The Unreality of the China Pigeon

Posted on July 23, 2020 by Christopher Balding

There is a new breed of China watcher stalking editorial pages. Potentially concerned, though not always, about various China misdeeds which few deny but clinging to unrealistic beliefs about solutions or simply unwilling to adopt firm beliefs about solutions, the China pigeon is unable to target workable solutions with difficult choices. We see this easily tossed softness in a variety of guises that remain unable to grasp the difficulty facing the world today.

The first failure of the China pigeon is an unrealistic belief in the non-China state of the world. For many this is an obvious defense mechanism. Many of them agree that China has done bad things like Xinjiang and Hong Kong so clearly they cannot be faulted because they agree with you. Where this pigeon goes wrong is in holding unrealistic views on the non-Chinese world. The most obvious, but just one of many that could be cited is the oft repeated but poorly understood phrase of relying on allies to challenge China.

In reality the fall back on clichés about allies are a defense mechanism revealing little more than intellectual emptiness about actual realistic state of the world or steps that could be taken to challenge China. They do not demonstrate any great profundity of thought but lack of understanding about the world outside their university campus or newsroom. Look around the world, talk to civil servants or political appointees in governments throughout Asia and Europe and one quickly discovers relative lack of interest for a variety of reasons to take any tangible steps to challenge China. Europe is in the midst of doing its best to appease China and Asia generally wants to avoid the topic as much as possible. The commendable idealism of those talking up the importance of allies to challenge China is quickly drowned in a sea of 2020 real economik politik.

We can seek to remake the world more to our liking but we must work with the world now as it is not as we hope it to be. The reality is that almost no countries have any real interest in addressing the myriad of problems obvious to the China hawk and China pigeon.

The second primary defense of the pigeon is the ability to spout profound sounding clichés that are nothing more than empty words devoid of policy steps that could be taken to balance reasonable concerns. China pigeons lack concrete thinking about how to address the myriad of challenges China presents. Skilled at critique and clichés, they lack ability to provide concrete policy steps to challenge China. The examples of allies reveals the bankrupt nature of these cliched talking points. Recruitment of allies, leaving aside the state of countries, is positive only if they can be marshalled into taking tangible policy steps to challenge China. China pigeons talk only of allies with no thought that this is only an intermediate step and not an end in and of itself. Most allies lack the willingness to even issue anything beyond vague concern over Chinese behavior but somehow these allies are the bedrock of enlightened foreign policy thinking.

Take a simple example. The leader of Europe Germany cannot bring itself to offer even any statement on China other than vague unspecified concerns about Chinese behavior. Falling back on the importance of allies is only valuable if those allies move much closer to the US position on China rather than the US moving closer to a German position on China. The inclusion of allies ultimately requires them to both honor commitments and gives them influence over the position. It would be a terrible tragedy if working with allies required watering down the US position on China. However, the China pigeon unable to recognize either the state of the world or requirements of allies believe that allies are simply a basic unqualified good.

Examples of the China pigeon as stunningly common despite the widely held perception that China hawks dominate. A recent blog post by Brookings capture this charade well. The post entitled “Why now? Understanding Beijing’s new assertiveness in Hong Kong” spends most of the piece analyzing Beijing’s strategy in passing the National Security Law. While reasonable people could have reasonable disagreements the author posits various theories about why Beijing chose the summer of 2020 to pass the NSL and gives nod to the fears they create. At this stage of the piece, if one read no further, you could be forgiven for believing the author would be in favor of any number of policies that would seek to punish Beijing. However, the blog closes with a few paragraphs that call for “goal of America’s presence in Hong Kong should be to keep as many relationships open with as wide a range of key figures as possible…(and hoping) the “one country, two systems” model can be preserved.” This is not any type of debatable policy response to CCP termination of civil rights like free speech. This is nothing less than dressed up appeasement of the rankest nature.

Another recent piece by Harvard professor Ezra Vogel talked about the need to continue engagement policies between China and the United States. Leaving aside the obvious failure of historical engagement that brought us to the point in time and enmity we are at now, the author compounds the original error by failing to grasp the state of the world outside of the college campus. It trots out the agency and context free one sided view that “it is not in the United States interest to turn the Chinese into our enemies. If we want to encourage them to work with us for our common interests, we need some fundamental rethinking of our policies.” The simplistic view of 2020 China makes two fundamental errors. First, the United States has worked for years to that end while China has engaged in an unceasing pattern of adversarial behavior. The shift in US policy and attitudes is not happening in a vacuum as the author supposes. Second, it further assumes the US is the only side in this relationship removing agency from the Chinese. At what point do the Chinese become responsible for their own country and making it a responsible actor in the global liberal international order? The last major problem of this piece is its complete lack of any mention of Chinese behavior. Forget Xinjiang. Hong Kong is never mentioned. Security threats are made up stories divorced from reality. Complicating this is that the author literally works at an institution where a colleague has been charged with illegally working with the Chinese but yet we are supposed to believe America is turning Chinese into enemies.

In the last highlighted piece, the author at least gives a nod the misbehavior of China in recent years writing in quiet confession that “I cannot excuse China’s behaviour in recent years…”. However, after this seemingly heartfelt and honest acknowledgement it falls a part in misguided logic and appeasement. The author actually argues that the current behavior is nothing more than a long pattern of behavior that should have been fully expected writing “What it is doing is not shocking if you have paid attention to the way it obtained power and has held it over the past seven decades.” If this is the case why was the United States engaging with this type of power so hard at all? This leads into the next piece of misbegotten and tortured logic. What has caused this conflict between China and the United States given the authors recognition of China’s “current behavior”? It is not China that is responsible for the state of affairs but the United States! The author argues that relations were driven by engagement which allowed, if we follow the authors logic, a malign state to metastasize but now the United States challenging these nefarious actions is driving the current state of conflict. This misguided logic is at least part right in that the relationship has tumbled because the United States has said this type of behavior will no longer be tolerated. Instead the author chalks the problems between the United States and China up to “blind confrontation” by the Trump administration. The author offers absolutely no suggestion, however misguided, of even a policy worth of consideration that might better respond to China’s acknowledged misbehavior other than continued engagement. Like many who will at least nod towards China’s behavior he authors nothing other than vague clichés. The reality is that the problems of decoupling are driven fundamentally and overwhelmingly by an increasingly intolerant and totalitarian China. While I personally sympathize and have lived the upheaval the author talks about of moving from China after living there for many years, it is nothing less than misguided appeasement of racial authoritarianism to continue a failed policy of engagement.

I could continue to cite example after example of people or institutions who try to sound enlightened looking at US China relations but fundamentally struggle to grasp the fundamental nature of the problem.

I believe there are three specific points that must be addressed for any argument to be considered reasonable. First, is the given state of the world an accurate representation of the reality we must deal with? To take a simple example, one is free to argue that greater ally involvement is positive, but any argument that fails to grasp the national level concerns of individual states can be considered nothing more than cliché writing. The hard reality is that irrespective of President Trump, countries have a myriad of issues that cause them to be reluctant or opposed to challenging China. That is the state of the world we must deal with.

Second, any argument of serious weight must present actual policy solutions. Let me emphasize, this is not clichés about challenging China or critiquing current policy but what are tangible policy options in the same tangible policy domain that would result in improved outcomes? For instance, when the Trump administration announced PLA linked graduate students would no longer be allowed to attend university in the United States, the policy proposal came under all nature of criticism such as cutting off lines of communication to racism but I know of no proposal to address the valid security concerns linked to an adversarial military power and key research put forth by any interested party. We must recognize the state of the world about China and the PLA and valid American interest in protecting certain information. In reality, barring PLA graduate students impacts a relatively small number of students and is not racially motivated and protects relatively narrow specific types of research. If universities want to argue for better policies designed to address specific downside risks or threats, I for one would be interested in how to better address valid and documented security issues. Until that time, there public demonstrations of concern are sound and fury signifying nothing.

Third, any serious argument about China must focus on the relative costs and benefits of cost imposition policy A v. cost imposition policy B rather than cost imposition policy v. status quo. In each of the examples cited, the underlying argument being made is that the deterioration in US China relations was due to US actions to punish or challenge Chinese behavior and that a return to engagement or no action should be taken. The Brookings piece actually said the recommended course of action was do nothing. This is simply not a remotely reasonable position. It is reasonable to debate whether an expedited visa policy, human rights sanctions, financial sanctions, or other policy actions should be taken or the details of these policies but returning to a policy of engagement or inability to take tangible actions against Chinese misbehavior is simply an untenable position. We should only be debating which cost imposition policy are we prepared to impose, accept the costs, and specific policy outcomes desired with comparison to results.

When the China pigeon is prepared to recognize the true state of the world, put forth words beyond cliched critiques, and engage in debate between cost imposition policies that challenge Chinese behavior, then and only then will they be considered credible.

1. https://www.brookings.edu/blog/order-from-chaos/2020/07/17/why-now-understanding-beijings-new-assertiveness-in-hong-kong/
2. https://www.washingtonpost.com/opinions/2020/07/22/us-policies-are-pushing-our-friends-china-toward-anti-american-nationalism/
3. https://www.businesstimes.com.sg/life-culture/kicked-out-of-china-and-other-real-life-costs-of-a-geopolitical-meltdown

Framing the Conflict with China

Posted on June 3, 2020 by Christopher Balding

There has been a lot going on in all things China and I think it is important to step back and put what is happening into a bigger picture framework and better understand the evolving conflict and specifically what the conflict is not. Let us start off by saying what the conflict with China is not.

1. The conflict with China is not due to Trump administration policy. This is an argument that to me is both nonsensical lacking any factual basis but speaks directly to many of the domestic political conflicts rather than the reality of China 2020. It would be fair to debate whether specific policy actions might have individually brought slightly different responses in narrow specific cases, but China has made clear across policy domains the nature, character, and direction of its domestic and foreign policy. The change and direction in Chinese foreign policy has been apparent for most of the past decade, definitely at least demarcated by the ascendance of Great Leader Xi in late 2012. Since then China has made no secret of its muscular foreign policy from the South China Sea to Uyghurs around the world and in Xinjiang to economic and industrial warfare. This strain of Chinese foreign policy began well before President Trump and will outlast a one or two term President Trump.

2. The conflict with China is not due to needing better communication or better understanding. Many have argued that due to Trump communication style, ending regular meetings, or lack of nuance the true failure lies with an inability to effectively communicate with China. This attributes to China a lack of intent about their actions rather than recognizing the reality that these actions and the larger framework within which they occur happens in a well planned manner to achieve specific objectives. The reality is that the policies that China is executing now have been planned and discussed clearly for years. Xinjiang, Taiwan, South China Sea, economic protectionism, Hong Kong, techno-authoritarianism these are clearly stated objectives by China across a variety of institutional formats that have been discussed widely within formal governmental forums and permissible propaganda type forums. To argue that the current escalated conflict is due to poor communication between the US and China is nothing less than staggering ignorance about what China has stated clearly and repeatedly as its objectives.

These two points, and various derivatives of the same generalized arguments, are made by China apologists, think tankers, and Open Letter writers as a form of condescending infantilization of China as if it needs to be shown the enlightened path upon which peace and harmony will reign. There are a couple of problems with this general line of thinking. First, it effectively believes the CCP and Chinese lack agency. If only they could be shown the light it would result in rapid change of events. In fact, Chinese writers have written at length both in official and unofficial circles about the projected growth of China in both political and economic terms. Official and unofficial China has thought long and hard about their preferred policy path and have the agency to make their own decisions about how to proceed.

Second, it implies that decision makers lack information about their decision set. In other words, engagers implicitly believe that due to wide spread state censorship in China, decision makers and political leaders have censored information and would benefit from better access to information and how their political decision making would result in better outcomes. However, decision makers have vast access to information and exposure to these ideas and policy options. Whether it has been studying abroad or censoring the specific ideas, it is a failed savior complex to believe that different information would change their behavior. They know why they are behaving in a certain manner and the decisions they are taking.

Third, this line of thinking require ignoring vast amounts of Chinese government work about what Beijing and the CCP sees as viable decision sets or alternatives. Put another way, China has said repeatedly over the years what they want to attain and they have dedicated vast amounts of of resources to attain its desired ends. Peter Mattis from the Congressional China Commission did a great Twitter thread on the wealth, depth, and modern history of documentation in planning and statement of intentions by China. I fundamentally disagree with their philosophy and objectives but they have put enormous amount of work and thought into their intentions, objectives, and reasoning. Believing any variation on the two themes of what the conflict is not requires one to believe that China has not done this, which we know is not true.
Fourth, engagers present this push to engage China as a brand new strategy when in reality their strategy has been the dominant strategy since the turn of the century. Their preferred strategy of how to prevent deepening problems between the United States and China is the exact strategy that brought relations to this point. If anything we have seen the complete and absolute failure of this strategy over the past 20 years but true believers, like communists, believe just a little more will make all the difference. Engagement advocates have truly had unfettered ability to demonstrate the efficacy of persuading China over the past 20 years and simply failed spectacularly. That this is even still discussed as a remotely viable strategy speaks nothing less than to the delusion of its advocates.

So this brings us to the fundamental question, and something that China apologists refuse to grasp, and many even hawkish to semi-hawkish China focused personnel struggle with: the conflict between China and the United States is a fundamental conflict between the values of open liberal democracy with human rights, and free markets at its core versus the closed authoritarian state centric governance system of China.
This sounds so simple but so difficult to grasp because it fundamentally changes the understanding of the conflict and how to resolve it. Take a simple example. In the first scenario, two countries are in a trade dispute. However, both countries agree that free trade is the driving objective, they agree what the rules of trade are, they recognize this as a narrow specific technical dispute that does not affect their other cooperation, they both accept how disputes are settled, and to accept the ruling in good faith and abide by the ruling making any changes. Now take another example. Two countries are in a trade dispute. However, the countries do not agree that free trade is the driving objective, they do not agree what the rules of trade are, it does impact their relationship in other areas beyond the narrow technical area, they do not accept how disputes are settled, and they do not in good faith accept rulings and implement rulings. There is an entire set of pre-dispute rules and framing that alter how we view the dispute and this this changes the entirety of how we approach the same exact same set of facts depending on the framing of each party.

What we have seen is that most people at the beginning believed this was a simple trade dispute between China and the United States. Even when the trade deal was announced, the structuring of the deal reflected a framework reflecting a fundamental dispute (refusal to negotiate foundational issues like subsidies), disagreement over the framing rules (managed trade in Stage 1 with free trade negotiated in Phase 2), and mistrust of the counterparty (target dollar purchases for China) even though most people continued to analyze it as a simple trade dispute. However, we knew as I said in April of 2018 how China would behave and using simple game theory this instructs us about how the Trump administration should behave and what the expected payoff from Presidential strategy replace given challenging China as the underlying principle. China is not approaching and has not behaved as if it is a marginal or technical dispute but cuts directly to the core of their entire political and economic governance philosophy. Why this comes as any type shock to any China watcher is a rather puzzling question but let us set that aside for now.

This understanding guides us into what to expect about the general path of the conflict between China and what will ultimately become large parts of the world. This is not a conflict about specific policies but about an entire system of human governance. This gives us a couple of principles moving forward about how to frame this conflict.
First, openness and engagement is relatively pointless with the objective to change Chinese government policy. I want to be very clear as I know how many will want to read this. Openness is good and useful policy across many policy domains and it still should be pursued pretty generally but we must realize it has little to no impact on changing Chinese government policy in a range of areas that would fit US government satisfactory policy sets or ranges. If openness and engagement with China actually changed Chinese government policy in the general direction of US or developed country democracy acceptable sets, the past 20 years would have yielded vastly different outcomes than where we stand. If anything the generalized policy of openness and engagement towards China has been shown to produce the opposite of its claimed outcome. I will leave aside the arguments for openness and engagement for now as they do not pertain to our argument about what type of conflict this is or the benefits but this should not be taken as an argument for closing up and blocking any interaction with China or Chinese.

Second, better negotiation or communication will have little to no impact on Chinese government policy. A common argument whether it is on bilateral basis, whether the personnel at the negotiating table, or at international organizations, a common argument is that better communication or negotiation strategies will give the US influence. However, the CCP will never negotiate its authoritarian stranglehold on China willingly. The CCP will not change its intent to establish a loose alliance of global authoritarians as a bulwark against open democracy due to better PowerPoint slides from well meaning DC think tanks. The CCP will not change its policies on import substitution and policies after reading a report from about what is really in its best interest in a Washington Post oped. It has not happened in since the turn of the century and it is not going to happen going forward.

Unfortunately this leads to a rather sobering direction on what it does mean for the conflict between the United States and China. It basically means a type of cold conflict will take place and we have already started seeing this effectively. I have no real interest in the specific linguistic terminology used. My preferred nomenclature is Cold War 2.0 but historians and linguists get puffy because the parallels are not exact but I do not have a strong opinion so if there is some type of widely adopted phrasing I will use it but for now I’m going to call it Cold War 2.0.

As the conflict is a fundamental conflict over the state of the world and system of governance, this leaves little room for negotiation but rather competition and conflict in most every policy domain promoting divergent visions of power and state to state interaction at every locus. In reality, this is what we have already been seeing for years. China has been a clearly revisionist power for example in the South China Sea seeking to take by force international waters in contravention of international treaties. China, as it has been for sometime well before the Trump administration, is actively working to cast forth a different vision for international organizations like the WHO. The xat Chinese strategy depends on the exact institution. At the WTO, Beijing will have difficulty changing the underlying agreements to its liking but they can drive it into irrelevance by keeping counterparties from pursuing disputes there, prevent any market opening reforms, and ignore agreements either technically or via lack of enforcement. Just as the United States built a variant of its own technocratic state on to the international arena after WWII and countries joined because the rules based system being projected globally, China is attempting to replicate its own domestic system globally.

It further implies that global institutions will become increasingly meaningless as they drift from their original technical mandate and agreement on either the terms of the institution itself mean and require of members or lack enforcement mechanisms (think WTO) or they become bogged down adrift in politics that prevent it from focusing on and executing its most basic tasks (think WHO or WIPO). We must remember that many of these institutions were created for the express purpose of challenging a major authoritarian communist or demarcating friendly states not trying to reform an existent authoritarian communist. Research across many disciplines have found that generally speaking whether a business or religion or other organizations that the more they dilute their membership the weaker it becomes in focusing on the mission, driving voluntary adherence, or that coalescing idea that made it great to start. In an era when China openly censors criticism on itself from pretty much any global organization, this creates problems in viewing global institutions as a channel for change in Chinese policy.
It will also require broad direct competition and challenges to China across policy domains and the establishment of a new international system. Cold War 2.0 will require United States competing and challenging China across virtually every policy domain about how best to project liberal open democratic human rights free market vision on to the world. Whether this is new international institutional arrangements or competing telecommunications standards or development funding for lesser developed countries, the United States must be prepared to challenge and compete with China across every policy domain. Every policy domain. The United States has been waking up to these challenges and is moving to address them but an enormous amount of work remains ahead.

If we exclude any type of armed conflict, which for two countries the size and technical sophistication of the United States and China would truly be catastrophic, the objectives and field of conflict become rather clear. It is an economic and world view conflict between closed authoritarian states and open liberal democratic system of governance. We can already see evolving soft alliances with China surrounding itself with DPRK, Iran, Syria, and other authoritarian states and building up other authoritarian states. This framework provides a few clear implications for how to approach the China challenge.

First, the United States must build alliances and institutions whether bilateral or multilateral but must be willing to exclude countries that are not good partners. The weakness of the global multilateral system is the total dilution of any agreed upon norms and values to which the members aspired. Even if the signed up for the words and the document, it is perfectly clear they did not agree with the mean and adjust their actions and policies accordingly. Just as China has built its own salad bowl of bilateral and multilateral institutions, the United States must challenge and compete with China whether in Asia or Latin America to work with countries that aspire to the same values.
Second, we need to recognize and behave as if there is an evolving type of Cold War split and countries need to treated as extensions of the larger framework. To take an example, though it may seem hard nosed, the United Kingdom cannot expect to receive special benefits and access to United States assets or markets while simultaneously allowing dangerous access to Chinese intelligence gathering assets. Other countries face similar decisions or tradeoffs. This makes it incumbent on the United States to both increase its cooperation and work with other countries while also making it clear that benefits can be excluded as well. Values need to be defended and that may come with a cost but if you respect those values the United States will support you.

Third, this means challenging countries that are align themselves with China. Just as we would take issue with allies funding the Soviet Union in the Cold War, we should understandably raise concerns about allies cooperating with China. Many have the concern that this is forcing countries to choose between China and the United States. This frames the questions incorrectly. One cannot both cooperate heavily with China like Germany is in Xinjiang, for instance, while also claiming to uphold the values of liberal open democracies. Germany and Volkswagen are simply funding brutal racist authoritarianism though kudos to remaining true to Volkswagen founding principles. It is not the United States forcing these questions but merely imposing costs. The same holds for states that are not allies like Iran. We cannot have détente and cooperation with countries that seek the benefits of working with the United States and its market without altering practices and policies. All sharing of benefits much be accompanied with specific sets or ranges of policies. Otherwise it is not us influencing them but us being influenced by brutal authoritarians.

Fourth, change in countries to whom we are in conflict with will come not by reasoned change of policies towards optimized sets but by imposition of painful outcomes from non-military policies. In other words, if we are in conflict with China and the CCP and we accept they will not negotiate into more open liberal democratic policy ranges accepting foundational beliefs, we must be prepared to impose upon them costs for their behavior that may ultimately force them to make those changes. For instance, that means taking action that may result in the collapse of a firm like Huawei. Enough of these individual actions together can increase the pain or narrow the decision set forcing changes in policy or raising the costs to maintaining the system. Make no mistake this is likely over time to impose significant costs and cause collateral damage to Chinese and Chinese allies but the United States must raise the costs of non-compliance to the values and norms we hold. To take one future possibility, if the United States were to begin crimping USD flows to Hong Kong due to its loss of special status, this may cause economic pain in Hong Kong as firms look to relocate and dislocates labor. While the United States should be careful, it cannot be held hostage by the CCP and must understand that when seeking to avoid any military confrontation, it must be prepared to impose these policies to raise the costs of behavior.

Fifth, we need to plan for and anticipate a long and costly shift in relations between the United States and China. We have crossed the Rubicon and China has laid bare their intentions. We cannot return to the days of blissful ignorance when the learned could feign ignorance on the goals, objectives, and intentions of China. That’s the reality. This is the conflict.

Why Europe is Irrelevant to Challenging China

Posted on June 2, 2020 by Christopher Balding

One of the most widely watched geopolitical events is how will Europe respond to Chinese aggression from the national security law in Hong Kong to the invasion of India as well as a range of other events. Given that many have built a counter Trump foreign policy contingent upon attracting European allies to confront China, the importance of Europe in the unfolding geopolitical tragedy becomes even more important. The only problem with the Old World obsession? Europe is almost entirely irrelevant to the China problem.

America has a European obsession. Coming out of a post World War II geopolitical environment there is good reason why that was the focus of resource allocation. This resulted in significant work that focused on the trans Atlantic relationship from bilateral and multilateral alliances and institutions to economic and security relationships that built the post war world. In a post war world, rebuilding Europe rapidly and building alliances to confront the Soviet Union was tantamount. This formed the foundation for the post war institutional and alliance order.

However, even beyond the broader institutional and alliance focus many in America looked to Europe as a natural ally that shared the same values but also behaved differently acting as a type of moderating influence on US foreign policy. They preferred to highlight different policy domains like the environment and human rights. They focused on institution building whether it was the European Union or whether it was NATO and post 1989 institutions. This endeared them to many foreign policy wonks in the United States who admired European sensibilities.

However, these threads of foreign policy and institutional alliances also overlooked key problems. First, much of this European cooperation flowed from the need to solve uniquely European centric problems. Whether the NATO security alliance facing the USSR to the United Nations Security Council with the two major victorious European powers as members or receiving financial benefits to rebuild Europe, enormous amounts of the cooperation involved European centric or adjacent needs, alliances, and institutions. In a post WWII world this is not a major problem. In a 2020 Asia focused threat theater, this is a problem.

Second, organizationally, Europe and the European are not really a political entity with delegated decision making, authority, and significant budgetary authority. Power for foreign policy within Europe continues to reside not with the European Union foreign minister but with the respective states foreign ministers. Each state has individual relationships with each other and with China and the issues that cause reaching and agreement to speak with a common voice on security issues half a world away a virtual non-starter. In reality, though we use the term Europe there is no European voice.
Third, Europe having received a security guarantee from the United States for most of the past half century has little interest in expending energy or capital on challenging China. Despite the criticisms of the Trump administration taking steps to make Europe take its own security more seriously and reduce American assets in Europe, this is a long standing problem faced by many Presidents dealing with a continent that is happy to free ride off of American security guarantee. While in European linked matters they may be able to muster at least some security assets to protect their own country, asking Europe to plausibly take interest in in security matters outside the Old World is simply a non-starter.

There are two separate issues to consider that are separate from Europe’s link with the creation of the international institution system. First, for a variety of reasons Europe broadly speaking does not see or refuses to address the potential Chinese threats. Despite the seemingly overwhelming list of reasons for Europe to consider China a threat, including many that fall directly into areas that Europe broadly prioritizes such as human rights and democracy, Europe almost without exception cannot even make strong statements about Hong Kong. There is a variety of reasons for this but fundamentally, Europe cannot be considered a reliable ally that prioritizes these values and policy issues willing to raise them with strongly authoritarian states. It bears worth noting that this pattern extends well beyond the China case.

Second, where as previous institutional arrangements prioritized Europe and European states played an important role in their creation and maintenance, the theater of engagement is now Asia. Even assuming the political willingness to challenge China, there is little to no ability by European state available to influence China other than scolding. They barely have a military to contribute to European defense much less projection into areas like the South China Sea nor can they even muster the ability to assist European telecom network firms like Nokia and Ericsson whom the US is trying to protect to help European cyber security. Think of it another way, after World War II, this would be like the United States proclaiming it was worried about the Russian marching into Europe and promptly flying to Asia to figure out what should be done. Europe can contribute minimally to the challenge ahead based simply on the theater of engagement.

So this turns us to the question of what is the framework for alliances and institutional building that lays before us?

First, rather than burning down the old institutions they are best dealt with by rotting under their own entropy. We do not need to dismantle NATO or the WTO for instance, nor would it be adviseable, we simply need not prioritize them. If other partners are unable or unwilling to invest in the maintenance or the reform of those institutions to make them valuable institutional resources, then the US should not waste valuable political and economic capital in attempting to make the impossible happen especially when those institutions cannot rise to meet the new challenges. However, this also argues against any destruction or withdrawal but rather a form of management into general irrelevance. If Germany does not wish to invest in its own security than neither will the US but we will maintain a security presence for our own needs in western Europe. Assuming no significant increase in military spending, this would require a reallocation of military assets away from western Europe and towards the Indo Pacific.
Second, this requires investing a new landscape of institutions and organizations designed to meet new challenges. As a simple example, the WTO language and ruling provide little hope for dealing with China in areas like state owned enterprises and separating enforcement from worthless technical alteration of legislation in an authoritarian government. Nor will the WTO be able to reform itself and the underlying agreements again. While newer agreements like CPTPP and the EU Vietnam FTA for instance, cover issues like SOEs in significantly greater detail with much broader language.

In reality we see the beginnings of system institutions that could form the basis of an actual Asian Pivot. President Obama first coined the term but had no follow through in accomplishing anything and President Trump has made targeting China a policy priority but worked little to institutionalize his approach outside the United States government. With the strategic approach document released recently which was a multi-agency collaboration document from across the US government and not a single office, there is a clear framework for moving forward. The US should join CPTPP and go further creating a directorate to coordinate and work with lesser developed Indo Pacific neighbors on standards, development, and investment. Recently, the Development Finance Corporation (DFC) was incorporated to finance development assistance though it currently has limited capital and borrowing capability to meet large broad needs across the Indo Pacific. While the US has ramped up security cooperation with partners in the Indo Pacific it needs to go further and begin to formalize a more institutional structure. This could take the form of military training and cooperation centers well short of anything that would replicate a NATO type control and mutual guarantee alliance structure it would lay the ground work for further institutionalization if needed by cooperating now.

Third, the reality that neither party really wants to acknowledge is that focusing on China will require both a significant reallocation or shift away from Europe and increase in current spending levels across policy domains. CNAS a left leaning security focused think tank in DC wrote a report entitled “Rising to the China Challenge” that came out in January about how the US should approach China by policy domains going forward. As much as a criticize Acela Corridor think tanks for their work on China, which is abysmally bad, the CNAS report was actually very good and got all the key points right. Where they stumble is they do not go far enough or lay out the realities of what they are implying: major increases in spending and major absorption of costs and refocusing of alliances and institutions. The fundamental framework and objectives they lay out is entirely correct. They stop short however of what the implication and the choices that will have to be made. This will require major increases in spending and a refocusing and redrawing of alliances to meet those goals and objectives.

Focusing on our example here, the United States does not need to kill NATO or the WTO but there is little clear reason for to invest or prioritize them if they are objectively failing or unable to address the new policy domains objectives. Furthermore, other than rubber rafts and unused vacation time, Europe can and will contribute nothing to Indo Pacific focused institutions, policies, and security strategies. The United States should not be bound by historical alliances to fight different security threats and economic objectives. Given the inability of Europe to project power and influence even within Europe what makes us think they could project influence to Asia?

There is broad interest in greater US involvement across a range of policy domains from greater security cooperation and training to economic development and trade. The US needs to prioritize working with other countries but not quiet in the way most people think.

China, the SEC, and Strategy

Posted on May 21, 2020 by Christopher Balding

There are a grab bag of issues that have popped up about China so let me try and hit them and wrap it all up into some type of coherent big picture idea.

First, I had heard recently Sen. John Kennedy had introduced a bill to effectively delist Chinese companies listed on US markets unless they effectively submit to big boy audits and SEC jurisdiction. This issue has been floated numerous times and in slightly different ways in the past couple years so I did not pay it much attention as many bills get submitted and die. I was surprised to wake up this morning and see that it has already passed the Senate.

According to Politico California Rep. Brad Sherman has already introduced a bill in the House with identical language. This is going to be interesting to watch the legislative sausage. What is notable is that it passed the Senate by unanimous consent. What makes this time so notable is there has been so little push back that have typically accompanied previous floating of this idea. I don’t know if this is simply because it happened relatively fast but given how it passed in the Senate, that will create enormous pressure in the House to pass it. The other issue is that there is no language about US investment capital going to China via indexes or other channels. This bill only deals with Chinese firms listed in the US. What is notable is that Chinese firms for most of the past decade have been allowed to eschew SEC jurisdiction and standard US accounting requirements for public firms. This matters because this bill does not impose any type of extra ordinary standard on Chinese firms, it only requires them to adhere to the standards that all other listing firms adhere to.

Second, the White House has released a document entitled “United States Strategic Approach to the People’s Republic of China.” The document is measured and realistic in its assessment of the challenge posed by Communist China. It includes such highlights as:

“ Since the United States and the People’s Republic of China (PRC) established diplomatic relations in 1979, United States policy toward the PRC was largely premised on a hope that deepening engagement would spur fundamental economic and political opening in the PRC and lead to its emergence as a constructive and responsible global stakeholder, with a more open society. More than 40 years later, it has become evident that this approach underestimated the will of the Chinese Communist Party (CCP) to constrain the scope of economic and political reform in China.”

“The CCP has chosen instead to exploit the free and open rules-based order and attempt to reshape the international system in its favor. Beijing openly acknowledges that it seeks to transform the international order to align with CCP interests and ideology. The CCP’s expanding use of economic, political, and military power to compel acquiescence from nation states harms vital American interests and undermines the sovereignty and dignity of countries and individuals around the world.”

“To respond to Beijing’s challenge, the Administration has adopted a competitive approach to the PRC, based on a clear-eyed assessment of the CCP’s intentions and actions, a reappraisal of the United States’ many strategic advantages and shortfalls, and a tolerance of greater bilateral friction. Our approach is not premised on determining a particular end state for China. Rather, our goal is to protect United States vital national interests, as articulated in the four pillars of the 2017 National Security Strategy of the United States of America (NSS). We aim to: (1) protect the American people, homeland, and way of life; (2) promote American prosperity; (3) preserve peace through strength; and (4) advance American influence.”

“Beijing’s poor record of following through on economic reform commitments and its extensive use of state-driven protectionist policies and practices harm United States companies and workers, distort global markets, violate international norms, and pollute the environment. When the PRC acceded to the World Trade Organization (WTO) in 2001, Beijing agreed to embrace the WTO’s open market-oriented approach and embed these principles in its trading system and institutions. WTO members expected China to continue on its path of economic reform and transform itself into a market-oriented economy and trade regime. These hopes were not realized. Beijing did not internalize the norms and practices of competition-based trade and investment, and instead exploited the benefits of WTO membership to become the world’s largest exporter, while systematically protecting its domestic markets. Beijing’s economic policies have led to massive industrial overcapacity that distorts glo bal prices and allows China to expand global market share at the expense of competitors operating without the unfair advantages that Beijing provides to its firms.”

“The CCP promotes globally a value proposition that challenges the bedrock American belief in the unalienable right of every person to life, liberty, and the pursuit of happiness. Under the current generation of leadership, the CCP has accelerated its efforts to portray its governance system as functioning better than those of what it refers to as “developed, western countries.” Beijing is clear that it sees itself as engaged in an ideological competition with the West. In 2013, General Secretary Xi called on the CCP to prepare for a “long-term period of cooperation and conflict” between two competing systems and declared that “capitalism is bound to die out and socialism is bound to win.”

“The CCP’s campaign to compel ideological conformity does not stop at China’s borders. In recent years, Beijing has intervened in sovereign nations’ internal affairs to engineer consent for its policies. PRC authorities have attempted to extend CCP influence over discourse and behavior around the world, with recent examples including companies and sports teams in the United States and the United Kingdom and politicians in Australia and Europe. PRC actors are exporting the tools of the CCP’s techno-authoritarian model to countries around the world, enabling authoritarian states to exert control over their citizens and surveil opposition, training foreign partners in propaganda and censorship techniques, and using bulk data collection to shape public sentiment.”

“Beijing’s military buildup threatens United States and allied national security interests and poses complex challenges for global commerce and supply chains. Beijing’s Military-Civil Fusion (MCF) strategy gives the PLA unfettered access into civil entities developing and acquiring advanced technologies, including state-owned and private firms, universities, and research programs. Through non-transparent MCF linkages, United States and other foreign companies are unwittingly feeding dual-use technologies into PRC military research and development programs, strengthening the CCP’s coercive ability to suppress domestic opposition and threaten foreign countries, including United States allies and partners.”

“The NSS demands that the United States “rethink the policies of the past two decades – policies based on the assumption that engagement with rivals and their inclusion in international institutions and global commerce would turn them into benign actors and trustworthy partners. For the most part, this premise turned out to be false. Rival actors use propaganda and other means to try to discredit democracy. They advance anti-Western views and spread false information to create divisions among ourselves, our allies, and our partners.”

“The United States holds the PRC government to the same standards and principles that apply to all nations. We believe this is the treatment that the people of China want and deserve from their own government and from the international community. Given the strategic choices China’s leadership is making, the United States now acknowledges and accepts the relationship with the PRC as the CCP has always framed it internally: one of great power competition. United States policies are not premised on an attempt to change the PRC’s domestic governance model, nor do they make concessions to the CCP’s narratives of exceptionalism and victimhood. Rather, United States policies are designed to protect our interests and empower our institutions to withstand the CCP’s malign behavior and collateral damage from the PRC’s internal governance problems. Whether the PRC eventually converges with the principles of the free and open order can only be determined by the Chinese people themselves. We recognize that Beijing, not Washington, has agency over and responsibility for the PRC government’s actions.”

“Beijing has repeatedly demonstrated that it does not offer compromises in response to American displays of goodwill, and that its actions are not constrained by its prior commitments to respect our interests. As such, the United States responds to the PRC’s actions rather than its stated commitments. Moreover, we do not cater to Beijing’s demands to create a proper “atmosphere” or “conditions” for dialogue. Likewise, the United States sees no value in engaging with Beijing for symbolism and pageantry; we instead demand tangible results and constructive outcomes.”

“Chinese students represent the largest cohort of foreign students in the United States today. The United States values the contributions of Chinese students and researchers. As of 2019, the number of Chinese students and researchers in the United States has reached an all-time high, while the number of student visa denials to Chinese applicants has steadily declined. The United States strongly supports the principles of open academic discourse and welcomes international students and researchers conducting legitimate academic pursuits; we are improving processes to screen out the small minority of Chinese applicants who attempt to enter the United States under false pretenses or with malign intent.”

“Having failed since 2003 to persuade Beijing to adhere to its economic commitments through regular, high-level dialogues, the United States is confronting China’s market-distorting forced technology transfer and intellectual property practices by imposing costs in the form of tariffs levied on Chinese goods coming into the United States. Those tariffs will remain in place until a fair Phase Two trade deal is agreed to by the United States and the PRC.”

This is a great, well written document that lays out the reasons for the policies clearly. Would definitely encourage anyone to read it as this will form the corner stone of China dealings for years to come.

Third, there was an interesting speech by Sen. Josh Hawley about the international system and his push for the US to withdraw from the WTO. Now I should say, I do not support withdrawing from the WTO for multiple reasons. For instance, the restraints it places on the US are really not burdensome or excessively costly. While Sen. Hawley notes that the US has lost 90% of cases where the US has been challenged, the US has also won similar amount of cases where it is the plaintiff. This is likely due to high probability that only egregious cases get challenged so defendants have higher probability of losing.

Looking at the bigger picture of what Sen. Hawley is saying there are some very interesting ideas. Without revisiting too deeply how the China shock impacted the United States, it is worth emphasizing that while yes on aggregate America did better by opening up to more trade with China, there is much to great a willingness to overlook the narrow and targeted shock felt by many industries and parts of the United States. I personally do not believe that trade policy is proper channel to address those specific economic challenges, but WTO and China defenders choosing to ignore those issues and segment that feel aggrieved for a variety of understandable and less rational reasons simply makes them sound removed from valid concerns.

One of the points which is likely to remain most overlooked in his statement, is the point that the GATT was designed to build up a system of like minded countries agreeing on the rules but the entry of and inclusion of countries like Russia and China altered dynamics fundamentally. Now it was meant as a broader mission trying to change norms and practices rather than like minded countries already having general view of the world and governance.

China has systematically worked to keep disputes out of the WTO threatening countries and seeking to later the fundamental understanding of the rules of engagement around trade, reciprocity, and national treatment. Though defenders of the WTO may argue with Hawley’s interpretation of events or WTO strengths or Chinese compliance, what is distinctly less arguable is how countries around the world have behaved with regards to trade agreements since the WTO and China’s entry. The WTO has not engaged in any significant reform this century either to its operations or trade rules. Yes, that it not necessarily a reflection upon the WTO as an organization. Countries around the world for the most part have moved trade agreements into bilateral or regional multilateral formats and chosen non-WTO formats for dispute resolution either in political or in other formats. Furthermore, newer trade agreements are covering issues around things like SOEs in bilateral and regional agreements that are not covered in the WTO and will not be allowed to be covered in the WTO. One can have reasoned disagreements with Sen. Hawley about some of his finer points but the reality is that countries have been behaving for some years to treat the WTO as an atrophying organization that does not provide the value they need effectively incapable of reforming itself to provide value. It is hard in a larger sense to disagree with the broader brush of his argument.

One of the major reasons I would advise against pulling out of the WTO is there is no agreed upon vision for what comes next and what it looks like. There are some positive and negatives but workable starts here. The biggest hurdle is there is no well formulated plan for what comes next and how to achieve it. The dispute resolution format described by the Senator are interesting but would need more work. Whatever the WTO short comings, it was pretty widely respected as a dispute settlement format because countries felt their complaints got recognized even if they did not always win. As an American I can say, most every case I know of where America lost, there was a very strong argument for America to lose based upon the agreement and behavior in question. Many countries would fear strictly bilateral format where they would face a super power like America alone. His proposal however does however speak to potentially addressing issues more frequently if they can be resolved through lower level arbitration or more speedily than multi year litigation where many times the market or situation has moved beyond the original dispute. What the Senator seems to be calling for more broadly while not explicitly laying it out in any detail, is broad economic alliance of like minded countries that stand in opposition to China and their like minded authoritarianism such as in Russia or Iran and the vassal state relationship Beijing seeks to establish with many Belt and Road countries.

I fully support this broad vision but there are two basic hurdles: first, this is actually a much more expansive and differentiated view of American foreign policy than most people realize requiring a lot of new work to execute. Whether one leaves the existing institutions or just allows them to atrophy, this vision of bilateral or multilateral agreements in trade and other policy areas of like minded countries requires an enormous amount of work. Given that this seems to be the beginning of a long Cold War type of period between China and the US, this is a reasonable approach but requires a lot more work and coalition building both within the United States across party and groups and around the world.

This could imply not simply rejoining TPP but beefing it up to give it a small secretariat or an economic development section. It could mean creating security cooperation mechanisms across the Indo Pacific countries that are concerned about Chinese encroachment. It could mean significantly expanding the newly established Development Finance Corporation to assist in economic development across countries that wish to be like minded about freedom and authoritarianism. Fundamentally, however, it implies a much broader institutional and agreement framework for the United States with other countries that does not currently exist.

Finally, the US will need to persuade countries that it is not simply trying to use bilateral power but will constrain itself to rules of engagement and behavior and persuade others of its vision for groups or alliances of countries concerned about the latent authoritarianism of China. The initial reaction by many will to discuss Trump but the reality is the US government as an institution must demonstrate the commitment to the Indo Pacific and willing governments. Europe is unlikely to play any meaningful role in dealing with China and has a long demonstrated lack of interest in their own security unless the United States provides it. The focus of relationship, alliance, and institution building should be focused in the IndoPacific. The US must demonstrate this through approval of trade regional and bilateral trade agreements. Increased allocation of resources from military training to development assistance and investment and visas for students from places like India and Vietnam. Many will be persuaded by this vision if the United States invests political and financial capital.

I believe there is increasing realization that there is significant scope to change a generation of relationships and rise to the challenge to confront an authoritarian China seeking to expand its authority and influence. Believe it or not, policy is moving in the right direction and great moves are being made to counter and address China. I have this sense there is a lot more to come.

How Fast is Corona Spreading and How Many Undetected Cases Are There?

Posted on March 29, 2020 by Christopher Balding

I had hoped to avoid writing a blog post on corona but there is one key piece that is informing public policy and driving the popular debate that simply does not match the underlying data that unknown researchers and doctors are finding around the world. That key question comes down to how fast corona is spreading and then and arguably more importantly how widely has it already spread beyond the observed confirmed cases?

Let us use a simple example and start introducing the starting point for what we are doing here. Let’s set the start date for corona as November 15, 2019 and say that the absolute first patient recorded in the Chinese medical system with a case of corona was the absolute first case. According to public Chinese records, the start date is accurate but this person would have been contagious before being discovered. It is also likely there were other unreported cases that helped it spread much wider and faster than our restrictive assumption but our goal here is to be very conservative in the number we report. So on November 15, 2019 corona started spreading in the population from a patient of 1. The question then becomes how fast and wide did it spread in Wuhan, China, and the rest of the world?

Now the beauty of these numbers is that I do not have to prove the current estimates are wildly wrong, which they do appear to be, but that they are not perfectly accurate. Let me give you an example. If we assume that the first patient was in Wuhan on November 15 and began infecting people at what we will assume is a fixed rate, the daily rate of growth through Friday March 27, 2020 based upon confirmed cases would have been 10.51%. In other words, if corona cases grow everyday from November 15, 2019 through March 27, 2020 by 10.5%, the numbers would grow from 1 to the number of confirmed cases of 596,000. The confirmed observed cases would account for the entirety of corona transmission vectors.

Does this match what the research shows us empirically? No. In this case there are two important assumptions being made. First, the assumed growth rate matches the real growth rate and all cases are observed confirmed cases. In reality both are false and we know both are false. What is important for our purposes here, is that they do not even need to diverge enormously for the end results to be significantly different. To again, take a simple example. Let’s assume, corona is really growing at 11% daily instead of 10.5% daily. How big of a difference does that make? Now the real number is of corona infections is not 596,000 but 1.1 million all because corona grew just a little faster than we expected. 12% becomes 3.5 million and 15% becomes 118 million with real infections outpacing observed infections by a factor of 200.

So now we need to focus on two specific questions: how fast is corona actually growing or spreading within the population and how closely do the observed and confirmed cases match what we know about real case spread in the population? Let me reemphasize: I do not even need to show that these two numbers are wildly wrong only that they are even a little wrong. We can easily show with empirical data that both of the popular conceptions are not just a little wrong but very wrong.

Let us start with how rapidly corona spreads. As we can show with simple match, assuming all corona cases are observed confirmed cases, corona grew at a daily rate of 10.5%. However, according to widely cited public sources, the daily growth rate in many countries is well above this.

Arguably the most repeated phrase in corona publicity is that it is growing at 30% daily. At the outset, we can discard this number as entirely unrealistic. How do we know? If that number were true of the virus from when it became known on November 15, it would have already infected 1.4 quadrillion people. However, this number must also be false even if we just focus on the United States. Again, how do we know? Assume the virus entered the US, roughly accurate assumption based upon existing evidence, on January 1, 2020 and grew at 30% daily, it would have already infected 6.3 billion Americans. In other words, it would have infected every American man, woman, and child 19 times. However, neither can it be the globally observed number of 10.5%. If it entered America on January 1, this would result in fewer than 6,000 corona cases. So the question becomes: how fast is corona spreading?

Before we look at what research from lots of countries is producing, let us point out, many theoretical studies are using the official World Health Organization number. This number typically sits in various modeling papers of an R0 between 2.0-2.5. I will save the notes about how poorly the WHO has handled things for another time but note here that papers like the Ferguson paper rely on these numbers. The Ferguson paper utilize R0 ranging from 2.0-2.6. A lower R0 says that the disease is spreading slower than a high R0 and would be more consistent with observed confirmed cases equaling the total number of real cases. A higher R0 means corona is spreading faster and implies higher numbers of unobserved cases. Given the WHO use of these numbers, many researchers can be forgiven for relying on them. However, are the official WHO R0 accurate?

In China, researchers generally put the R0 distinctly higher than WHO range of 2.0-2.5. One literature review of R0 estimates for China found “estimates ranged from 1.4 to 6.49, with a mean of 3.28, a median of 2.79.” One study from researchers at the Yale School of Public Health focusing on Wuhan discretely on the December 1 to January 1 time frame estimated an R0 of 4.1. Another paper focusing on China and using a mathematical model used by later researchers at Harvard, found an R0 of 3.3 and noting a daily growth of .3. There are a lot of studies that either directly or indirectly estimate this number but there are not many studies from China supporting the WHO claim of R0.

What about other countries? In Iran, one team of researchers estimated the prelockdown R0 at 4.7 though dropping to under 2.0. Another team focusing on Iran from Georgia Southern University estimated the R0 at 3.6. Another team from Iran studying Iran estimated the preloackdown R0 at 4.9 the first week of infection dropping to 4.5 and 4.3 before entering lockdown where it dropped to 2.1. What is notable in this case is that even when implementing movement restrictions the R0 for corona still remained within WHO R0 range.

In Italy, Chinese researchers estimated an R0 of 4.1 compared with their estimate of 3.15 for Wuhan. Other Chinese researchers comparing South Korea and Italy found R0’s of 2.6-3.2 and 2.6-3.3 respectively. An Italian mathematician using standard disease modeling softward found an R0 of 3.5. One researcher doing a cross country study estimated Italy at 3.8.

What is notable however is in countries that appear to have been doing well. In South Korea, numerous pieces of research found examples of “super-spreader” clusters with R0 around 4 with the rest of the country on heightened alert having a very low R0 around 1 in this case. One researcher estimated that the total country R0 was at 3.8. In the case of Singapore and Tianjian, China some Canadian researchers found that even with significantly more restrictive measures R0 at 1.97 and 1.87 just barely below the WHO standard range but within the margin of error.

There are a few specific notable take aways from this brief literature review. First, this research was all done using very standard methods. Second, like any research area there will be a range but there is striking similarity in arriving at R0 numbers that are materially different from the WHO range. Third, even in some countries held up as examples, significant steps appeared to only push the R0 just below the WHO range and not even below 0. Fourth, events are unfolding too fast that we do not have research on other countries like Germany, Spain, and the United States. Fifth, these findings indicate that the disease spread much more than the WHO guidelines. This is important because as has been noted earlier, to demonstrate the broader point, I only need to demonstrate that corona grew a little faster than believed. The weight of evidence clearly demonstrates that corona grew much more than is believed. This has a major and material impact on public policy.

This leads to the second important question of what percentage of real corona cases are captured by observed and confirmed corona cases people watch on the internet? Importantly for our purposes, there are many factors that would lead us to miss corona cases. In sum, these add up to a large percentage of missed cases. Let us detail some of the problems.

First, the speed is wrong which tells us how many to look for. The WHO estimates have guided numerous theoretical models which are relying on faulty assumptions. Think of it another way. Think if you are flying a plane and you only have directions to fly in a specific direction at 500mph. Unbeknownst to you however, you have actually been flying at 1,000mph. So when you look at your watch and the directions say you should start to see the airport, you cannot find it. We can say with a pretty high degree of certainty that based upon empirical country by country analysis, the spread is much broader than WHO guidelines advise.

Second, testing in most parts of the world, especially China and Asia, is significantly flawed with high numbers of false negative tests. Research from China finds false negative tests on 30-60% of positive patients with some studies going higher. Let us use a low estimate and say 25% of cases who got tested for corona tested negative were actually positive and they in turn infected one other person at some point. Both are low estimates but for our simple example will work. In an additional attempt to be conservative, I will do this only for China. This gives us an additional 27,00 additional cases just from false negatives and if we assume they each infected one person, this gives us a total 54,000 new unknown cases. How big an impact would that be? That increases global cases by 9.1%.

Third, we know that numerous key countries record cases differently leading to large undercount. Leaving aside political interference, we know that China for instance states they do not count asymptomatic or only mild cases even refusing to test. Mild an asymptomatic carriers are still transmitters of the disease even if they do not require significant care, hospitalization, or ICU access. According to places that have taken broad quasi random or population tests, asymptomatic and mild cases of corona are the large majority of all cases. For our purposes, we will again undercount this population and assume them to be 50%. So if China records 82,000 moderate to severe symptomatic cases, this will imply an asymptomatic or mild population of 82,000. We make the same follow up assumption, each of these people then infected one additional person. This gives us an additional population of 164,000 cases not counted in official data. We now have 218,000 new cases just from how data is counted. This would be equal to 37% of total global cases. However, there are other channels through which corona cases have been missed.

Fourth, another class of people that are missed in the total count is the number of infected that never get tested or consider getting tested for various reasons. This could range for having mild symptoms so that one has no reason to get tested or that no symptoms present in the patient. This is actually quite common. Just as a simple baseline, of the roughly 40 million estimated flu cases in the United States every year only about 40-45% of those result in medical visits. Another way to think of these people is people who did not even know they were infected. While we would be justified in setting this number as equal to confirmed cases, we want to be conservative, so I will set this as equal to one third of confirmed cases across some major countries. Let’s take a low round number of 200,000 untested cases based upon 600,000 global cases. This now raises our missing count to 418,000 out of 600,000 total global cases though that number rises daily.

It cannot be emphasized enough, the numbers I have added to confirmed observed cases are very conservative based upon highly restrictive assumptions. What I have done here however, is used theory and anecdote to build a very simple and conservative model of how many are missing. The question is do we actually see evidence based upon documentation and research of the missing cases I am arguing are out there? In short, absolutely AND in much higher numbers than I am conservatively estimating.

We know of a few places, and I am absolutely not excluding others only that these are the ones I know about, where we have either quasi random or broad population testing. These tests are not perfectly random but they give us clues about how broadly spread throughout the population corona is beyond the observations being taken at hospitals and medical centers or by self selected individuals.

Iceland has taken a broad population sample that now comprises nearly 5% of the entire population. There is not much detail about the specific testing criteria but the reports are that it was designed to test for corona in the population and not merely sick at the hospital or a medical clinic. According to Icelandic data available from the government, they recently listed 963 confirmed cases for a positive rate of 6.6%. Sounds bad right? Actually, because of the testing criteria, most people did not even know they had corona because they did not feel any worse. Out of the 963 cases only 19 needed hospitalization and only 6 needed ICU care. In other words, while there have been some tragic outcomes, corona is already much more wide spread and it has no or only mild impact on most people who tested positive.

In Holland, a similar thing happened. Hospitals in the Netherlands started seeing reports of corona and had a couple staff members fall ill from corona. To make sure their staff was protected, the conducted a broad population testing on medical staff to see how prevalent corona was among front line personnel. According to their data, after testing 1,353 they found 86 positive tests for corona a rate of (tell me if this sounds familiar) 6.4%. Only half had a fever and most positive cases continued working because they felt either no different or symptoms were so mild. Notably under existing criteria 40% of positive cases would not have been even tested because they did not have a known risk factor.

Westchester county in New York implemented an aggressive testing plan. Their tests were largely by self selected individuals and needed to pass a criteria screening protocol so it is different from Iceland and Holland in key ways. However, they have tested 29,000 people. What have they found? They registered 7,187 positive result for a 25% positive rate. This large jump in positive rate is expected from self selected individuals that pass a screening protocol. So what is the severity? 73 hospitalized and 12 deaths in county. In other words, from positive cases in Westchester county, hospitalization rate of positive cases is running at 1% and deaths are running at 0.26%.
There is another case of broad population testing. The first resident of Vo, Italy died from corona in late February. Local officials being aware of corona virus spreading in China with the help of a local university opted to quarantine and test the entire city of roughly 4,000. Now it is worth noting that Vo is a small remote town in north eastern Italy. It is not one of the major cities which would have lots of international traffic. 89 people out of 3,300 or roughly 3% of the population tested positive after they discovered one death. There is no additional data but they do not report additional tests and actually advised people against going to the hospital unless they had severe problems. Testing two weeks later revealed positive tests dropped to roughly 0.5%.

What we have seen in each of these four cases is very broad infection levels well beyond either the expected infection levels and very low levels of severity relative to the total number of cases. In other words, if we factor in the unobserved cases that are being found this dramatically changes our view of the broad severity of corona. What has been taking place before is observations being recorded at hospitals of sick people needing medical care. This gives us a biased view of disease severity. This is like going to a car crash and then making a decision about all vehicular traffic. What is potentially most notable is that the number of real cases of infection relative to observed cases of infection is not off by a percentage but many many magnitudes. In other words, the unobserved real transmitters do not comprise even 50% of total cases but like many magnitudes of observed cases.

However, are these four cases with seemingly reliable data from different places an outlier or are they consistent with research from other places? In fact, they are very consistent with research from other countries about corona spread.

One paper by American researchers conducting a cross country study with anchor countries estimated that Chinese confirmed cases were under estimated by a factor of nearly 10. If remotely accurate that would more than double existing cases globally. Mathematicians at the university involved in testing Vo wrote a paper estimating that globally undetected cases are four times larger than detected cases. What makes these asymptomatic carriers so difficult is that they may not even know they were exposed and are disease carriers. Other Italian researchers reached similar conclusions writing “our model predicts that when the first 3 infected cases had been identified by Italian authorities there were already nearly 30 cases in Italy…only 0.5% cases had been detected and confirmed by Italian authorities. While oﬀicial statistics had 132 confirmed case we believe a more accurate estimate would be closer to 26000.” This is important because it reaches general conclusions in line with the Vo population sampling. UK researchers using different methods reach similar conclusions finding that “by the time a single death occurs, hundreds to thousands of cases are likely to be present in that population.” Even statisticians from the Italian National Institute of Statistics have completed research finding that corona is likely at least ten times more wide spread than official cases.

A key aspect here is how the disease spread from China in the early stages when they were censoring information. One cross country study from China, the UK, and the US using a combination of unique datasets estimates that undetected cases in China account for 86% of all corona cases. Another study found that though Wuhan was the epicenter, for every one case exported internationally from Wuhan other major Chinese cities exported 2.9 cases that “likely remained undetected”. Japanese researchers focusing on Wuhan re-estimating real infection rates rather than official Chinese rates with asymptomatic transmission estimate that real infection was much lower with actual time delayed fatality rate of 0.12%.

One of the key areas is how much this under detection of asymptomatic travelers led to disease spread. A research paper between researchers at Peking University and Cedar Sinai Hospital in Los Angeles estimated there were roughly 10,000 asymptomatic carriers who flew from Wuhan and China to the United States as of March 1, 2020. Researchers at Harvard found most countries had low level capability to detect asymptomatic travelers setting their detection rate to 38% of Singapore noting that “estimates of case counts in Wuhan based on assumptions of perfect detection in travelers may be under estimate by several fold, and severity correspondingly over estimated by several fold.” Another similar study found that even under the best of circumstances more 50% of carriers would not be detected because they would not have symptoms and many would not even know they had been exposed. It is worth noting that research generally find that disease detection for corona is very hard given the prevalence of asymptomatic carriers.

In short, not only are the real number of cases under estimated based upon observed confirmation data, they are likely enormously under estimated. As one can see from the research by in country researchers from Iran to Italy and Japan, there is a range of magnitude but there is significant agreement that the real number is off by at least numerous multiples.

This post has already gone on too long but I wanted to document the logic and the research that supports what I think is happening. The two primary key ideas so far are that corona has spread significantly faster than the WHO estimates and that there are large amounts of undetected cases of corona. So what is the importance of all of this and what does this mean for policy makers?

First, track and trace is a pointless. If your confirmed cases account for only 50% of your threat vectors you would have a hard time constraining the spread. If your confirmed cases account for 10% of your threat vectors track and trace is little more than a waste of time. Undetected transmission cases are simply too numerous and wide spread to make track and trace effective.

Second, case severity out of the infected population is actually much much lower and by one account on par with flu outcomes. Current numbers widely used in the press grossly distort the reality by measuring data at known severe outcome locations. This is like measuring driving safety at a hospital. The overwhelming number of observations will be severe cases. When looking at the population wide data, case severity appears radically different. This is not to say corona is only the flu as we do not have the depth of data to say that, only that it is decidedly less severe against infected population which when adjusted are decidedly less severe than they first appear.

Third, the two primary points here actually dovetail nicely. For the R0 to be higher than the WHO guidelines, we needed to have significantly higher population estimates. We have significantly higher infected population meaning the R0 is significantly higher. The results are complementary.

Fourth, the most widely cited Ferguson paper therefore relies on factually incorrect assumptions by assuming a much lower R0 that is only reached according to one paper under lockdown and by assuming there are very few undetected cases. We can say with a high degree of certainty both assumptions are wrong and enormously impact the scientific validity of the paper.

Fifth, governments would be well advised to focus mitigation efforts on less intrusive and disruptive behavior rather than near total economic shut downs. Other countries have focused on factors like increased mask wearing to help slow transmission. Put another way, more targeted precision policies rather than the broad blunt disruptive measures we have seen.

Sixth, a key factor in outbreaks has been super spreader nodes. From South Korea to Italy, there are clear examples of super spreader nodes. In many cases those nodes can be responsible for the overwhelming number of cases. Rather than disrupting an entire country, it is important to focus efforts on mitigating and detecting those nodes.
Seventh, there are clear examples of medical resources being taxed at super spreader locations. Public policy interventions would best be focused on helping allocate medical resources to specific locations rather than using broader blunter instruments. Whether that is through dispersing patients throughout large metro areas or short term larger facilities. Importantly, it would help to focus on targeted resource allocation to impacted areas rather than broad more coercive interventions.

Let me emphasize a few brief final points. First, nothing here is intended to down play or pretend corona is not a significant health risk. Do not behave irresponsibly. However, the panic and debate clearly suffers from profound misunderstandings. Second, I do not mean to sound insensitive when writing here. Clearly people are dying and there are difficult problems. My intent is simply to try and grasp what is best research and data telling us about the risks and best approaches.

The final pieces of research I will leave you with are this: a meta study of corona R0 found a pooled R0 number of 3.32 with a mean of 3.38; probability of being diagnosed correctly with severe symptoms at 0.6, diagnosis probability with mild or asymptomatic at 0.001, and the probability of developing severe symptoms at 0.01; higher transmission from interval between incubation and symptom onset allowing carriers to infect larger number of people.

Hope I’ve given you something to think about.

Addendum: I wrote this on Word and for some reason the links did not transfer. I have uploaded the document with links here in a PDF to the research for anyone that wants to review what I have cited.

Prioritizing China in the Upcoming Budget

Posted on February 20, 2020 by Christopher Balding

President Donald Trump has released his proposed budget for 2021. Despite making it the center piece of his domestic and foreign policy, his budget does little to institutionalize his initiative or prepare America for the longer term challenges presented by the Chinese Communist Party. America and President Trump must commit to investing significant resources not just domestically but globally in the fight against a China seeking to remake the world in its authoritarian image.
If every President has one dominant issue they can focus their political capital on addressing, for President Trump it is China. FBI Director Christopher Wray called it a “whole of society” approach to deal with China across a variety of policy domains.
Trade policy has focused on decoupling meant to move key industries out of China with government agencies purchasing electronic equipment increasingly requesting that no part of the product comes from China due to security concerns. The FBI has targeted researchers who allegedly shared federally funded research with China and lied about their involvement with Chinese universities or companies.
Their concern with China extends to foreign policy. The Trump administration has been pushing countries around the world to ban Huawei due to its documented links to the Chinese military and intelligence agencies as well as products that remain notably unsecure even by countries using them. The Trump administration has raised valid concerns about the Belt and Road Initiative led by state owned banks working under the Communist Party.
What the Trump administration has not done is bring significant financial resources that would institutionalize and demonstrate its political commitment to entice others. The Trump administration must acknowledge and sell that the United States cannot challenge an expansionist authoritarian communist state as the worlds second largest economy on the cheap. Policy must be backed by financial and institutional resources beyond executive directive.
This raises a thorny question: given the rancorous partisanship what type of spending increase would both parties be willing to approve and how would it be paid for?
There is a major need for increased spending in military readiness to maintain a free and open Indo Pacific. As a recent report from the Center for Strategic and Budgetary Assessments made clear, the United States Navy lacks the type of assets needed given new weapons systems and challenges faced by countries like China. There is also significant need for broader military alliance building in Asia. Countries throughout the Indo Pacific from Indonesia, Vietnam, and India face regular security threats from Chinese naval incursions. From military development assistance, training, subsidized sales of hard ware and institutionalization of regional military cooperation between friendly states, there remains significant scope to expand softer forms of military cooperation.
There are key spending items sure to please Democrats as well. China has rolled out a nearly trillion dollar investment program known as the Belt Road Initiative building out infrastructure in emerging markets and ordered state banks to help national champions like Huawei. Leaving aside the rampant corruption and excessive indebtedness that liter the trail of Chinese investment, the US for many years has failed to step forth with anything that resembles a viable alternative. It may leave countries with significant problems but it gives China deep influence buying elite friendship.
While the dreamed of Green New Deal is unlikely for numerous reasons, the United States could have a much more significant impact environmentally by funding a multiyear capital allocation to an institution like the Import Export Bank that helped emerging market countries invest in infrastructure in a more sustainable and ethical manner. A Development Green New Deal could be used to help emerging market countries, who also happen to be those targeted by Chinese influence operations, invest in environmentally friendly infrastructure.
This is not charity or ideological environmentalism. With more than 50% of the worlds population centered in south east Asia home to the most rapidly growing economies, these countries are seeing their demand for energy consumption sky rocket. Currently investing heavily in fossil fuels, these countries are blessed with abundant solar radiation and wind that would make them ideal candidates for heavy investment in renewable energy that would be cost competitive with coal. The US could reduce public involvement and leverage its enormous private investors by covering only specific risks needed for long term infrastructure investment like long term currency movement in frontier markets.
This should not be limited to developing countries either. The Trump administration has pleaded with European allies to recognize Huawei as a security risk and block them from telecom networks. Global 5G spending is forecast to only amount to $11 billion in 2020 and 2021 according to Gartman Research. The United States could easily fund a capital allocation to the Import Export Bank or similar institution to allow them to provide low interest financing to countries blocking Huawei from their network. With Chinese state policy banks providing zero interest long term financing to entice countries. The United States needs to do more to lead than just lean on goodwill.
There are a variety of other needs where increased spending would institutionalize and allocate the needed resources to challenge China. From hiring more Chinese speaking officials across policy domains to address the threat China poses within the United States to more diplomats abroad to make the case for democracy and openness. We cannot talk of meeting the China threat without the tools from law enforcement to diplomacy needed to confront that challenge.
To realize meaningful spending increases and not increase budget deficits beyond already stretched limits, the US will need to raise taxes somewhere. Though this may be politically distasteful, with US federal revenue as a percentage of GDP at historical lows, there are options to increase revenue without remaking tax policy. Trading off GOP priorities of military spending and pro-business internationalism for environmental and public employment with improved revenue should help make it more palatable to both side.
Just as the United States faces a whole of society challenge from communist authoritarian China, we must be prepared to respond in a whole of society manner. President Trump is right to prioritize China but needs to recognize he lacks the institutional tools and resources to challenge them. Passing a budget with whole of society bipartisan objectives is the place to start.

Public Policy Options for Financing Global 5G Rollout

Posted on February 13, 2020 by Christopher Balding

Below is a rather long post about the financing of 5G roll out and public policy options given the subsidized financing being received by telecom operators from non-market states and firms. I have also uploaded it as a paper which you can find here and may find more readable given the length.

Managing the Finances To Keep Huawei Out
Leaving aside technical and national security issues, a fundamental driver of the interest in Huawei gear by telecoms providers is the low cost. There is no systematic data on cost, but anecdotally industry contacts routinely tell of Huawei bidding 25% less with some deals having significantly greater equipment discounts. To address the challenge posed by Huawei, it is important to address and narrow the financial gap. It is important to note that the total financial cost gap between non-market subsidized firms and market based companies is significant and comes from multiple channels directed by the total state involvement. Furthermore, they utilize business practices that are not allowed by market based democratic countries. While appeals to national security are notable and important, democratic market based countries must better address the total cost differential to make market based competitors feasible alternatives for telecommunication providers looking to purchase the low cost products.

How Big Is the Net Cost Gap?
The anecdotal data on headline price fails to capture the full magnitude of the cost discrepancy between non-market and market competitors. Let us create a simple model to better capture the enormity of the total cost discrepancy between non-market and market based telecom gear competitors. It should be noted that this is a simple model intended only to illustrate the size of the discrepancy but does generally reflect what people in the telecommunication service sector space have told us about the pricing on non-market network gear. Greater detail on variables like bond pricing and discounts would be needed to truly capture company specific results but for our purposes it will work.

I make two key assumptions to break out the total net cost difference to telecom providers. First, I assume that non-market firms are providing gear discounts of 25%. In our model, a market based competitor sells gear for $1 billion while non-market sells for $750 million. The spreadsheet is attached so that users can change discounting to play with the numbers. It is worth noting that Chinese non-market companies have completed deals with significantly greater discounts. We use 25% as a baseline but it is important to note that in total cost, this comprises only a small portion of the total subsidy provided to telecom providers by non-market competitors.

Second, upon fixed standard long term GBP bond pricing for Vodafone found on the London Stock Exchange, I assume the interest rate to be 4%. Based upon looking at other bonds issued by Vodafone, we believe this is a reasonable pricing based upon current interest rates. In the spreadsheet provided, users can adjust based upon their belief. While I have chosen a UK company for illustration purposes given the decision taking place, this basic model remains widely applicable to others. For instance, Deutsche Telekom borrowing in euros faces a cheaper cost of capital than Vodafone borrowing in pounds but we can adjust this on a country by country specific example.
I use the term total cost gap to encompass additional factors that better capture the cost factor facing a telecom provider. First, telecom providers will raise financing typically by issuing debt to pay for the cost of the 5G buildout in all facets including spectrum licensing and hardware requirements.

Second, telecoms providers care more about the total system cost than the headline equipment cost. Many people will notice the 30% discount but telecom service providers will also focus on the cost of financing, typically a larger cost, as well as installation, maintenance, and replacement lifespan. In other words, what is the total cost in monthly cash flow expenditure rather than off the shelf sticker price.

Third, sources within the industry have said non-market network firms offer Chinese state sponsored financing incentives. These may include but are not limited to interest free financing, loan periods up to 30 years, payment holidays for up to 2-4 years, and total financing as high as 130% of the equipment purchase to cover ancillary items such as installation, training, and future maintenance. Consequently, we consider the total net cost inclusive not just of initial equipment expenditure but of ongoing monthly expenditure from debt and related items.

Including these simplified examples and assumptions, which we believe are accurate but also conservative, yields rather stark differences. Assuming a telecoms provider purchases $1 billion in 5G network gear or $700 million in Huawei gear with the same functionality, the yearly cash repayment expenditure for just equipment would require nearly seven times higher cash expenditure if using a non-Huawei market competitor with no repayment holiday. If the telecom service provider opts for a three year payment holiday, that included financing for maintenance and installation, this would take forecasted cash expenditure in year 1 from zero to $291 million annually in the first three years. This provides a high hurdle to market competitors pitching telecom service providers.

The Broader Financing Model
There are a couple of important framework factors here for why telecoms providers are taking their specific stance which provide policy options. Telecoms providers are heavily indebted due to upfront bids for 4G spectrum and the expected bids for 5G spectrum which flow to the public purse. In other words, telecoms providers are already heavily indebted and seek to restrain their overall indebtedness after purchasing spectrum. This is a major and frequently overlooked aspect of the Huawei bid that interest free financing is in strict numbers a bigger cost subsidy than the discount on gear.
If governments are going to make credible push to block Huawei, they have to be willing to adjust policies for telecom providers that recognize the financing problem and the cost hurdle faced by telecom providers. Pleas for national security only go so far for governments unwilling to recognize the financing problems.

There is one clear proactive step that governments can take that will fundamentally alter the financial framework of the 5G debate. Shifting from an upfront cash spectrum auction requiring the telecom providers to incur significant debt and financing costs to royalty bids whereby governments receive a percentage of revenue over time.

There are a number of important issues to unpack here. First, one of the overlooked benefits Huawei provides via vendor financing is not simply the lower cost of debt but the quasi-hidden nature of the increase. For instance, by choosing a market based competitor, the telecom provider must then go to the debt markets to raise capital. With Huawei, there is no loan application it just comes with the equipment. Furthermore, depending on how creative each party wants to get, it is possible that the telecom provider does not even officially incur debt through potentially creative structuring. It should not be overlooked how important this ability to finance the entire infrastructure cost, installation, and maintenance with no public debt issuance will be to many firms.

Second, the net debt to the country does not change but it comes at a lower cost. By shifting financing to a royalty system, assuming the government wants the entire amount from the beginning, there will be no net debt change but will lower the financing cost, it will only be shifting who incurs the debt moving it from the telecom provider to the state. In a spectrum auction with cash upfront, telecoms are incurring a long term debt on behalf of the state who is selling a long term asset but wants all of the cash upfront. Because the telecom firm obtaining long term use of a public good, the telecom is better served paying for ongoing use with long term obligation to continue paying. If the government wants the cash up front from the underlying cash flow, they should securitize the stream of cash flow. Importantly, sovereigns will be able to lower the cost of borrowing by roughly 3-4% and that 3-4% is largely captured by the telecom as the debt is now shifted to sovereigns rather than telecoms. Put another way, even with the telecom paying the same net present value to access the spectrum and the government receiving the same total cash payment at the beginning of the contract, due to the lower sovereign debt financing costs, each party receives improved financial position.

Third, the important issue financially, will be how to make market based network competitors cost competitive to telecom providers recognizing the tradeoffs and avoid market distorting measures like explicit and implicit subsidies. How can the terms of the total package be changed to make the two choices significantly closer in cost perspective recognizing the important financial framework?

Shifting Costs and Revenue to Balance With Potential Public Solutions
A fundamental problem for market economies to address is how specifically to manage the financing of 5G rollout with component manufacturers that are secure vendors given the cost differentials. Below are some policy ideas to shift how revenue and costs are received or allocated between the different parties with an eye towards changing the cost motivation for telecom providers.

The simplest policy option would be shifting to a strict royalty based system, assuming the net present value, the amount the government could raise today for selling a future stream of cash flow, remains unchanged but lowering borrowing costs by shifting from corporate to sovereign rates. While there remains additional work needed to be done to narrow that cost differential, this at least moves us substantially closer.

There are also ways to bring those costs closer together primarily by raising costs on products that require risk mitigation strategies and working to lower costs on network manufacturers that do not. Below are some policy ideas. Let me strongly emphasize, these are rough ideas and more intended to give readers things to think about not just on how to narrow the cost differential but to manage the specific risks. Here are some very rough policy proposals:

1. Give firms that legally commit to using no gear requiring mitigation strategies the option of using the royalty option or upfront fee. Firms that refuse to provide networks free of gear requiring mitigation must choose the upfront bid fee. In this case, the state is providing a clear financial incentive to use less risky network equipment. Under the current system, to take a simple example, the telecom service provider bids $1 billion for the ten year right to use a specified spectrum range. In this case, the service provider incurs debt at corporate rates to provide upfront cash for the bid to the state. However, a simple switch to royalty system whereby the state received a percentage of revenue from 5G users would provide a major financial incentive.

2. Provide firms using exclusively non-mitigation gear accelerated depreciation schedules. Most phone network gear will be replaced every 4-5 years and early generation 5G equipment is likely to be replaced even earlier.

3. Given that firms have a desire to use what is acknowledged to be high risk gear even by those wanting Huawei in the system, this provides the perfect case to “tax” the gear similar to something like cigarettes. The tax revenue could be used to fund two separate activities. First, an independent cyber agency dedicated to managing all risks within the high risk network. Revenue would be used to fund reviews of network, software, and hardware updates funded with a tax on high risk vendors. Specifically, it is important to make this entity entirely independent from Huawei similar in nature to the Czech cyber agency. Second, it would be used to fund research and develop open or common source software for 5G hard ware that provided market firms ready secure options. For years security analysts have noted the glaring security vulnerabilities of Huawei gear that Huawei claims would require billions of dollars and years to solve. Rather than remain dependent upon Chinese source code to run critical telecommunications infrastructure, assist outside options to ensure the highest level of security.

4. Users of high risk gear could be required to fund insurance via a lock box to cover claims. Just as in the insurance world, higher risk drivers and companies pay more to access capital markets, it is reasonable create a lock box fund to cover risk losses. For instance, this could be used to cover replacing network gear, losses from hacking via high risk gear, or network outages from high risk gear. Given the acknowledgement the non-market providers present significantly higher risk, it is reasonable to require financial mitigation strategies and funding.

5. The primary boost to non-market network gear cost competitiveness comes not from the discounted sticker price but the non-market financing provided by the Chinese Communist Party state owned banks. Legislation should cover non-market financing that are not allowed within OECD countries. For instance, there are strict limits on OECD countries providing financing support to help exporters via vendor financing in areas ranging from aircraft to power and other infrastructure mandating interest rate floors and total financing packages. Chinese banks do not adhere to these standards. The US Import Export Bank may only be able to provide, for instance, 70% financing at interest rates comparable to high quality corporates currently 2.9% with shorter duration matching the expected life span of the asset in this case say 5 years. The China Development Bank and other Chinese state banks acting at the direction of Beijing, will offer 130% financing for 20 years at zero percent with a three year payment holiday. There should be strict legislation about the use of non-market financing by countries and companies not just within the OECD but also covering adversarial states like the People’s Republic of China.

Incorporating some of these proposals, we are able to significantly alter the financial impact being claimed. If we use say a 5% levy on insurance risks which is actuarially plausible and a 10% levy to fund a completely independent cyber risk agency, this would further alter the cost competitiveness between non-market and market competitors to more reasonable levels.

If we simply move to a system where service providers using no non-market equipment use royalty system rather than upfront fee with the non-market high risk gear being assessed fees to compensate for the increased risk, the cost ratio significantly narrows from year one. This changes the underlying cost basis but does not address the financing mechanism arguably the largest source of China’s cost advantage for Huawei.
Countries like the United States however, have opportunities that can be brought to bear should they be utilized to address the financing of crucial infrastructure assets. Let us spin out a simple financial example of how this could be achieved at published rates.
For simplicity sakes, let’s assume that the United States government wanted to offer a financial incentive to European states to choose market based network providers. Either by itself or in partnership with some multilateral institution such as the European for Reconstruction and Development it could issue, for our simplistic purposes, a 10 year bond denominated in euros when lent to European allies. For our purposes, we will assume a US government bond issued in Europe will be priced comparable to German bond yields at the same duration.

In this scenario, the United States could borrow currently at -0.4% for 10 years. Based upon published OECD rates and for simplicity sake, we assume that the United States would lend this capital out to European allies that agreed to not use and remove all non-market based network gear from its telecommunications system. This puts the financing of telecommunications on a more competitive basis with non-market competitors.
This changes the bottom line for telecommunication service providers significantly. If we assume that service providers receive the baseline equipment discount and financing package from a non-market manufacturer but then pay a tax levy on high risk equipment and must pay an up front auction spectrum fee or have the option of market priced gear with a multilateral financing option that does not pay a risk mitigation tax and has the option of spectrum royalty, the cost differentials are significantly narrowed.

A telecom service provider facing a simple market and non-market network gear decision coupled with financing options faces a cash expenditure cost ratio differential that is 6.3 times higher to choose a market based provider. However, by making some small changes that address the Chinese Communist Party state led subsidized lending, changing spectrum financing options, and higher risk costs there are very reasonable methods to bring this down to much narrower cost differentials between purely market and non-market equipment providers.

There are a few final notes in closing. First, despite the belief that this would require enormous sums of money the numbers are actually low enough the United States could finance global 5G roll out. According to a 2019 research report by Gartman, 5G network investment will rise slowly in the coming years totalling $4.2 billion in 2020 and $6.8 billion in 2021. In 2020, 5G network investment will account for 12% of total network spending globally. Even in China roughly 10% of the population is expected to be on 5G by the end of 2020. Even if we expand the roughly $11 billion in 5G spending to include other network investments, excluding 4G and other standards, this would still bring us to only around $20 billion in investment through the end of 2021.

This matters as this becomes a palatable financial commitment for the United States to make in support of allies that exclude non-market competitors from the network. If the United States were to allocate a capital increase to the United States Import Export Bank or similar agency such as the European Bank for Reconstruction and Development totaling $5 billion over two years this would more than cover global 5G investment. This would allow, using a 400% debt to equity ratio baseline, $20 billion in borrowing at sovereign rates. These agencies could borrow on euro debt markets and lend to European allies who banned non-market competitors providing competitive financial package.

Second, despite these basic cost comparisons, non-market subsidized firms comprise merely a portion of the network portfolio operated by major telecom service providers. This matters because actually the costs to a telecom service provider to remove all non-market firms from their network is significantly less as a portion of the total spend. British Telecom has announced it would cost £500 million to remove non-market telecom gear providers from its networks. While this sounds significant, lost beneath the headline is that this would take place over 5 years or approximately £100 million pounds a year out of annual network investment of more than £2 billion. For a company like Vodafone, we have an even better picture. Their estimated network investment of £3.5 billion a year would require approximately £50 million annually to remove non-market gear providers from their network. While we should not dismiss the real costs that blocking subsidized equipment would impose on telecom service providers, we similarly should not overstate the costs.

Third, the United States can make reasoned appeals since the Bush administration continuing through Obama and now into Trump but this must be met with investment of both political and financial capital. Though the risks from non-market state subsidized firms have been recognized by countries from the United Kingdom to the United States for more than a decade, making the argument requires more than rational pleas to technical evidence of extremely poor or malicious security behavior in internet network gear. The United States must take the lead dedicating both political and financial capital internationalizing the argument away from personalities.

Fourth, if a government prefers to receive the cash up front, as they would in spectrum auction, but still switch to a royalty, the state would have no problem issuing a securitized bond backed by royalty payments. Given the fact that this specific debt is backed by an ongoing stream of payments, in most cases does not actually count as increasing debt to GDP as it is backed by a stream of payments and considered off balance sheet. For Euro area countries this is not an insignificant matter seeking to remain below specified debt limits.

Conclusion
Lost beneath the headlines of valid security risks from adopting non-market telecoms network gear are cost considerations of service providers. The financial framework for telecom service providers and the interest in the state in receiving non-debt cash payments has tilted the incentives towards manufacturers that provide disallowed OECD financing packages. By working to fund risk mitigation activities, return to unsubsidized lending, and shift to royalty based system, there is significant scope to reduce the cost differentials between market and non-market telecom manufacturers. Perversely the state is incentivizing telecom service providers to depend on China for state subsidized financing by relying on spectrum auction cash up front rather than shifting to royalty auctions. By providing such abnormal financing terms, China is driving up auction prices increasing the upfront cash to countries. If states are concerned about the security risks to using network gear, the simplest policy change they could make is allow firms who legally commit to keeping Huawei gear out of the network to switch to royalty payments.

Cost Comparison
Non-Market Gear Manufacturer Market Gear Manufacturer Year 1 Cost Ratio Cash Flow Differential
Option A: Equipment w/M&I Only $45,000,000
($0) $284,627,113 6.26 $239,127,113
($284,627,113)
Option B: Equipment w/M&I and Different Financing $45,000,000
($0) $160,000,000 3.52 $115,500,000
($160,000,000)
Option C: Non-market gear & spectrum fee v. Market gear and spectrum royalty $119,081,751
($73,581,750) $210,000,000 1.76 $90,918,249
($136,418,250)
Option D: All of Option C plus Risk Mitigation Fee for Equipment and Services of Non-Market Firms $146,381,751
($100,881,750) $210,000,000 1.43 $63,618,249

Option A: Service provider faces non-market telecommunication manufacturer sells $700 million worth of gear plus $210 million of maintenance and installation services. Everything is vendor financed for 20 years at zero percent interest with immediate repayment and three year payment holiday or market interest assumed to be 4% for five years given the expected equipment life span with maintenance and installation financed from cash flow and expended in the same year. We make the assumption that the relative cost for maintenance and installation is the same. Number in parenthesis is the holiday number.
Option B: Service provider faces non-market telecommunication manufacturer selling $700 million worth of gear, equivalent to a 30% discount, plus $210 million of maintenance and installation services. Everything is vendor financed for 20 years at zero percent interest with immediate repayment and three year payment holiday or multilateral agency offering zero interest with ten year repayment beyond the expected life span but less than the non-market firm with maintenance and installation financed from cash flow and expended in the same year. The relative cost for maintenance and installation is the same. Number in parenthesis is the holiday number.
Option C: Service provider faces non-market telecommunication manufacturer selling $700 million worth of gear, equivalent to a 30% discount, plus $210 million of maintenance and installation services. Everything is vendor financed for 20 years at zero percent interest with immediate repayment and three year payment holiday or multilateral agency offering zero interest with ten year repayment beyond the expected life span but less than the non-market firm with maintenance and installation financed from cash flow and expended in the same year. The relative cost for maintenance and installation is the same. Number in parenthesis is the holiday number but now with the year spectrum fee financed over 20 years at market rates. The primary difference in Option C is that telecommunication service providers are required to pay cash up front if choosing non-market gear while others can choose a royalty with the same expected net present value in upfront payment to the government.
Option D: Service provider faces non-market telecommunication manufacturer selling $700 million worth of gear, equivalent to a 30% discount, plus $210 million of maintenance and installation services. Everything is vendor financed for 20 years at zero percent interest with immediate repayment and three year payment holiday or multilateral agency offering zero interest with ten year repayment beyond the expected life span but less than the non-market firm with maintenance and installation financed from cash flow and expended in the same year. The relative cost for maintenance and installation is the same. Number in parenthesis is the holiday number but now with the year spectrum fee financed over 20 years at market rates. Telecommunication service providers are required to pay cash up front if choosing non-market gear while others can choose a royalty with the same expected net present value in upfront payment to the government. The difference between Option C and Option D is that telecommunication service providers are required to pay a risk mitigation fee for using network gear from high risk vendors to fund insurance and management activities. These taxes are collected as a percentage of the total equipment and service purchase paid out over 5 years the expected life span of the equipment.

The Case Against Huawei

Posted on January 15, 2020 by Christopher Balding

Introduction

The debate over the inclusion of Chinese telecommunications firm Huawei into the network of developed countries has provoked a heated battle. The debate has taken rhetorical turns veering off into a variety of tangents and logical arguments rather than focus on the facts that are known about Huawei. Here I will attempt to correct that by presenting facts that are known about Huawei. I will then present analysis based upon what these facts imply. There are a couple of important caveats that are important to note.

I will stick to publicly known facts as much as possible. In other words, the facts I use will be drawn from various forms of archival research and are publicly available to anyone who wishes to dig enough for these facts.
I will use non-publicly available facts where necessary and most likely will not disclose the source of that information. However, and I cannot stress this enough, everything I present here is entirely documentable. Put another way, any facts presented here are no reliant on personal sources or rumors but on activity that can be clearly documented and proven.
Any trust worthy person or institution that is interested in reviewing documentation that is cited here is welcome to inquire. Due to the sensitivity of the data, I will not be simply dumping the data online but I will be more than happy to share data with credible parties.
I will try to limit analysis and when analysis is presented will try to clearly delimit the difference between fact and analysis. I believe the facts largely speak for themselves and typically need minimal analysis that any educated person would be unable to easily connect.
This is not new research but generally a summary or presentation of existing facts. It should thought of more as a memo detailing why Huawei should be considered a high risk vendor. I will try to hit key questions and issues that have been raised covering reports on Huawei by other entities. This will attempt to be succinct covering of major issues rather than in depth research on narrow specific topics.

Is Huawei a private corporation?

No, Huawei is effectively a state owned corporation in the People’s Republic of China under the Communist Party. Technically, the firm known as Huawei is Huawei Technologies. Huawei Technologies is 99% owned by Huawei Investment Holdings. Huawei Investment Holdings is completely owned by the Huawei Investment Holdings Trade Union Committee. According to Chinese law, trade union committees are classified as “public” or “mass” organizations. Public organizations do not have shareholders as they are recognized under Chinese law as legal persons or entities in their own right. An example of a public organization would be the Communist Youth League.

The Huawei Investment Trade Union Committee is under the umbrella of the All China Federation of Trade Unions. The ACFTU works on an umbrella structure in that firms are under local branches. Local branches are subsumed under city branches which are under county level branches all the way up to the national branches. ACFTU employees are treated almost as civil servants serving the Party and government interests being paid on civil servant pay scales. The current head of the ACFTU which ultimately owns the controlling stake in Huawei Investment Holding is the Vice Chairperson of the Standing Committee of the National People’s Congress.

While Huawei continues to publicly proclaim they are a private firm, the corporate and legal records clearly prove they are “public” or “mass” organization that is effectively state owned. Interestingly, in a conference call with journalists, Huawei personnel actually stated that this is their legal status despite their continued public declarations.

Does it Matter Who Formally Owns Huawei?

No, it does not. The Chinese Communist Party has placed CCP official in oversight roles in all major companies. This includes carrying out CCP directives from small such as increasing public spirit and studying Xi thought to bigger issues such as access to data for all public officials. In other words, Huawei is not a private company and the CCP has directed all companies to follow the Party.

Does Huawei Work With Chinese Security Services of Various Kind?

Huawei has a long and intimate history with Chinese security services of all types. Founder Ren Zhengfei has a well documented background as a senior commander of the People’s Liberation Army. Due to the timing and opacity of documentation about his time in the PLA, there is some confusion about his exact rank or status though it is clear that he was rather senior. It has also been raised that at the time there were few choices for able bodied men which also has some truth.

What has been widely overlooked however is the broader depth of early personnel links between Huawei and the People’s Liberation Army. Numerous leaders of Huawei, both past and present, have long standing and deep ties to the PLA across disciplines or background. As one example, the Chief Legal Officer of Huawei who has appeared regularly in foreign media proclaiming the lack of ties between Huawei and the PLA actually received his Phd in electronics and communications from the National University of Defense Technology also known as the People’s Liberation Army National University of Defense Science and Technology. This is a military university under the direct control of the China Central Military Commission. Put another way, the Chief Legal Counsel a leader of Huawei declaring its lack of ties to the PLA received all his university degrees from a PLA university in electronics and communications before joining Huawei. There are many other examples of senior Huawei personnel past and present with similar links to the military or security services.

Beyond historical personnel links, Huawei maintains very close ties to the PLA, Ministry of State Security which focuses on external intelligence, and the Public Security Bureau which focuses on domestic intelligence. Huawei researchers have demonstrated dual appointments with PLA research units which one case likely falls under the Strategic Support Force which leads Chinese cyber warfare and intelligence gathering efforts. In another instance, a Huawei employee doubles as the MSS liaison or representative. Huawei personnel work in depth with the PSB building domestic surveillance and censoring technology. There are extensive, in depth, and long historical links between Huawei and all sectors of Chinese state security.

What Does Chinese Law Say About Intelligence Gathering and Data for Chinese Firms?

Chinese law is perfectly explicit on these matters: Chinese firms are required to help with all requests of intelligence gathering or requests for information by public officials. Furthermore, the Chinese state shall have access to all data held by Chinese companies or foreign firms in China at any time. Though Huawei has publicly said they would deny these requests from the Chinese government, we know Huawei products give network managers the ability to intercept these information and we know that Huawei stores vast amounts of this information on users.

Does China provide state support for Huawei?

There is a long history of China providing state support for Huawei. Dating back to the late 1990’s and early 2000’s, the China Development Bank was providing low cost financing for Huawei customers. This typically took the form of guaranteed financing to Huawei for customers that were many times annual revenue updated every few years. Additionally, Huawei received a wide variety of grants and tax breaks to promote research, jobs, and low cost land acquisition. By one report, this amount topped more than $75 billion. The ability of Huawei to essentially guarantee financing provided a major boost to sales driven by Beijing foreign policy objectives through the China Development Bank.

State support however comes in other forms. For instance, Huawei has been involved in joint ventures with Chinese telecommunications carriers and local governments which appear to provide funding for operations and research. In other words, there appears to be some cost sharing in some cases for local operations.

In other cases, Huawei researchers work with professors or researchers from PLA or other military linked universities on research covering a variety of topics from general network reliability, to wifi, encryption, and 5G to name a few. Huawei technical experts have been on technical commissions with PLA and security experts domestically focused on external threats and capabilities as well as having broad networks with PLA and intelligence electronics and signals research.

Is Huawei the Technological Leader in 5G?

No. Many patents have been filed pertaining to 5G but this does not mean all of the patents are truly useful or important to 5G products. Based upon the widely used technology industry metric of “standard and essential” patent, Huawei ranks generally anywhere from 4^th to 6^th globally. Other firms like Nokia, Ericsson, Samsung, LG, and Qualcomm are leaders with Intel and Sharp ranking just behind Huawei and ZTE. While Huawei attempts to paint themselves as a market and technological leader, there simply is no evidence that they are a technological leader in 5G.

Does Huawei Engage in Intellectual Property Theft or Intelligence Gathering For China or Itself?

Yes, on both accounts. We have clear evidence of Huawei personnel gathering technical data on competitors products. Additionally, there is clear records of Huawei personnel engaging in behavior that states foreign data collection capabilities which ties back geographically and time wise to known events. Given the amount of offensive hacking capabilities Huawei has at multiple locations throughout China and other offices in countries with widely recognized superior cyber threat capabilities, the threat to countries by Huawei should be taken quite seriously. Finally, Huawei personnel talk about putting information interception capabilities into domestic and foreign destination hardware. While we cannot specifically discern intent or end use, Huawei personnel clearly state the capabilities at hand.

Is there Evidence Huawei or China Are Using Existing Capabilities to Gather Data on Foreign Firms or Individuals?

Yes. Huawei and China maintains extensive databases on foreign individual, firms, including but not limited to work product, intellectual property, facial characteristics, camera IPs, call records, and others. We cannot tell whether this is being conducted via existing backdoors in Huawei gear but we can tell it is data that should not necessarily be in Chinese databases.

Is Huawei Network Gear a Security Risk?

Yes. This has been said by every foreign government entity that has looked at it including the United Kingdom Huawei Cyber Security Evaluation Center and the Czech National Cyber Security Center. FiniteState which produced a detailed report of Huawei products on their security vulnerabilities came to the conclusion that:

Huawei devices quantitatively pose a high risk to their users. In virtually all categories we studied, we found Huawei devices to be less secure than comparable devices from other vendors. Through analysis of device firmware, we discovered that there were hundreds of cases of potential backdoor vulnerabilities – improper default configurations that could allow Huawei or a malicious attacker to covertly access a user’s device. These vulnerabilities manifested in the form of hard-coded, default user accounts and passwords, and several types of embedded cryptographic keys. The study also found that each Huawei device had a large number of known vulnerabilities associated with the third-party and open-source libraries embedded within the firmware. On average, there were 102 known vulnerabilities (CVEs) associated with each firmware, a significant percentage of which were rated as high or critical in their severity.

While intent is difficult to discern as we do not know why specific vulnerabilities made it through into production devices, Huawei devices have significantly more known vulnerabilities than comparable products. Given the state link with employees declaring their activity and the data found in China, it is not a stretch to consider this is being used to harvest information.

Is Huawei a National Security Threat?

Defining national security broadly yes. For instance, we know that Huawei is continuing to deal with Iran having evidence of their continued dealings as late as November 2018. Huawei built the mobile network for North Korea. They are one of the dominant cloud providers of data collected on foreigners for China. They have provided security, surveillance, and censoring services to authoritarian governments. Even if we exclude the question of whether there are backdoors, very weak, or problematic security on their network gear, defined more broadly, they clearly pose a national security risk to democratic states.

Is Huawei a Human Rights Violator?

Yes, at home and abroad. Huawei is heavily involved in Xinjiang training police forces and prison officials in the use of technology covering everything from facial and gait recognition, population monitoring, and cloud services to capture the flow of data. They are direct service providers to local governments some of which have been placed on the United States government entity list. Though Huawei was placed on the entity list for different reasons, their work for human rights

Unpacking The No Deal Not a Trade War Trade War Deal

Posted on December 15, 2019 by Christopher Balding

Having been subjected to such a barrage of horrendous trade war analysis that seems more like literary therapy for the politically frustrated than actual deal analysis, I have opted to write my own analysis of the deal. I will as studiously as possible try to avoid or limit any political opinionating, and stick strictly to the analyzing the deal points within the USTR Fact Sheet and providing what are the likely trade offs, risks, and perspective about each points. Let’s get started.

This deal is about a lot more than agriculture.

I’m leading with this one only because it is arguably the most common myth and repeated like the 10 Ten Commandments and divine truth even though it is clearly false on numerous levels. The USTR specifically lists IP protection, tech transfer, agriculture, financial services, currency, expanding trade, and dispute resolution as the major areas. One report in the news quoted a source as saying there were 9 chapters which would come close to matching these general areas. Even within the broader trade purchase aspect, agriculture is not even the main area. Let us please kill once and for all, this deal is just about agriculture.

Intellectual Property and Technology Transfer

The two paragraphs on IP and tech transfer in the USTR statement provide scant detail but use relatively ambitious language with regards to Chinese commitments. In IP, China will “address long standing concerns”. In tech transfer, the language is even more ambitious saying China “agreed to end its long-standing practice of forcing or pressuring foreign companies to transfer their technology to Chinese companies as a condition for obtaining market access, administrative approvals, or receiving advantages from the government” and “commits to provide transparency, fairness, and due process in administrative proceedings and to have technology transfer and licensing take place on market terms” and “commits to refrain from directing or supporting outbound investments aimed at acquiring foreign technology pursuant to industrial plans that create distortion.” Taken at face value absent additional detail on execution and assuming right now China follows through, this would represent an enormous change to Chinese practices both at home and abroad. Realistically, this is unlikely to change Chinese behavior and will likely be one of the examples used when this deal blows up.

Agriculture and Expanding Trade

While there is stalker levels of obsession with the agriculture purchases by China, around which the details are still somewhat unclear, the more interesting and important part which most everyone has missed is the total trade purchase commitments by China. Some reports have agriculture purchases as $50 billion a year and some have them as $50-60 billion over 2 years. Let’s circle back to the importance here after including in the bigger total trade commitment. The language in the USTR Fact Sheet says China will “import various U.S. goods and services over the next two years in a total amount that exceeds China’s annual level of imports for those goods and services in 2017 by no less than $200 billion.” For simplicity sake, in 2018 Chinese imports of US goods and services totaled $180 billion according to the USTR. According to the USTR Fact Sheet, in 2020 and 2021, China will purchase $180 billion + $100 billion in each of the next two years. Depending on the details, agriculture will comprise roughly 10-20% of the total trade commitment by China in these two sections.

Financial Services and Currency

China also agreed to open its financial services industry and not manipulate its currency specifically “refrain from competitive devaluations.” Couple of points worth noting. First, many will rush to point out China has already started opening up its financial services sector. Reading between the lines, it is not conspiracy level thinking to say that China engaged in those reforms in anticipation or in cooperation with the US side so that it would be sold as a domestic political reform rather than a concession. This has been a long long standing issue for the US, and while it is primarily Chinese domestic banking weakness driving the issue, let’s not pretend it doesn’t matter. Second, currency management is a tricky issue because there are so many ways to view the same exact issue. Let me give you an example. If we take as a given that China has fixed the value of the RMB to a basket of currencies known as the CFETS which effectively acts as a reverse USD index (when the USD rises, the CFETS index and RMB fall), then there is only minimal to moderate evidence China is manipulating the RMB. In this case, the value of the RMB may be manipulated for relatively short periods of time such as a few weeks, but has largely remain relatively aligned with its implied index value. In other words, in recent history the RMB has been weak because the USD has been strong. However, there is a glaring weakness with this argument. China is managing its currency by fixing it to a basket of other currencies. That is clearly managing the value against the USD. Take another example. One of the short term moves in the RMB that occurred largely independent or even against the basket happened around tariff imposition. That clearly speaks to the Chinese interest in managing the value of the currency around political events.

Dispute Resolution

There is a short paragraph on dispute resolution and creating regular bilateral consultations. The detail is too scant to make any real declarations or analysis of this, but it is interesting to note and will be interesting to see if this becomes a more regular forum to manage disputes.

This summarizes the major points of the detailed 1 ½ page USTR Fact Sheet which is the most comprehensive document published so far. I think there are a lot of perspective, tradeoffs, and risks that I think need to be covered.

In this deal, who gave up what and what did they receive?

According to reports, the United States agreed to lower tariffs from 15% to 7.5% on $110 billion of the total $350 billion of tariffed goods and delay tariffs on goods scheduled to go into effect on December 15. This means the US still maintains a 7.5% tariff rate on $110 billion of goods and 25% on $240 billion in goods. For agreeing to lower the tariff rate on one tranche of goods and delaying tariffs scheduled to take effect, the United States received ambitious commitments covering intellectual property protection and tech transfer (both long standing complaints of the United States), ambitious import commitments, financial services opening (another long standing demand), commitments not engage in competitive devaluation, and dispute resolution. If we take the agreement as detailed scantly by the USTR and assume that China abides by its commitments (assume for a moment), this should be considered a good deal for the United States based upon a few criteria. First, focusing simply on the non-purchase agreements this addresses long standing demands by the United States. Second, if we focus on the quantitative trade metrics such as tariffs and purchase commitments, the United States received total trade purchase commitments far in excess of what it committed via tariff reductions. In rough terms, assuming trade levels return to non-tariff levels (a generous assumption), tariff reductions from 15% to 7.5% will generate roughly $10-15 billion in exports for China in the next year. Conversely, based upon the existing data and import commitments, China has agreed to increase total imports from the US by roughly $120 billion in 2020 compared to 2019 based upon my rough math. Put another way, the United States made a $10-15 billion commitment to China while receiving a roughly $120 billion commitment a differential of roughly ten times. Third, if we consider the negotiation strategically and trade off, the United States in total received much more in value than it yielded and retains significant leverage going forward. Considering that the United States maintains a 25% tariff rate on $240 billion in goods and 7.5% on $110 billion, they maintain significant ability to monitor ongoing compliance. Then the value received for the delay of December 15 tariffs and reduction of tranched tariff rates should be considered substantial.

What are the risks in this deal?

We start getting into the good stuff! The risks on this deal are simply enormous. Off the top of my head right from the beginning, leaving aside the Chinese history of cheating on deals, I would have to put the risk that this deal doesn’t see 2021 as close to 50%. The risks that this deal falls apart before entering into force is not insignificant, though I’m going to assume it does. There are a few specific risks which I think are quite sizeable here. First, the targets and commitments required of China are significant and ambitious. In total import purchases from the United States, China will need to increase imports from the US in 2020 by 55% from its recent full non-trade war year high of 2017. If we consider the base as 2019, then 2020 relative increase could be close to a 100% increase. That is an ambitious target by any standard. Then consider the process changes such as IP, tech transfer, and financial service opening, and those are ambitious requirements. Given China’s broader recentralization of the economy and judiciary that is required to follow Party leadership, it is difficult to see how these commitments play out in practice. Needless to say, there is enormous risk in those areas that China fails to meet its commitments putting the deal at risk. Second, arguably the biggest risk is that the Trump administration, aware of the complete lack of follow through on deals by previous administrations is likely to have very low tolerance for failure to meet targets by the Chinese. I fully expect China to pretty wildly miss their commitments laid out in this deal in every area. Based upon history this is a fully rational expectation, so then the only question becomes what is the expected reaction of the Trump administration? I think it is perfectly rational to believe the Trump administration has relatively low tolerance for non-compliance. If China only increase US imports by $80 billion from the 2017 base in 2020, I doubt the Trump administration will blow up the deal as China will have demonstrated at least good faith efforts for instance. However, I doubt China will or even intends to make good faith efforts to meet all their commitments. I will gladly be declared to be wrong at the end of 2020 if I am wrong. Third, based upon comments from both sides there is still significant ambiguity about key aspects of the agreement. It can only be considered a negative if each side disagrees about their respective commitments. Probably the biggest question mark concerns the expected speed of US tariff roll back in the future. China seems to expect this to happen relatively quickly and the US side has made conflicting and ambiguous statement. Under a normal agreement, we would expect to see a schedule for roll back. To take a simple example, for every month China imports $25 billion of goods and services from the United States, the United States will lower import tariffs on the 7.5% tranche by 1% and on the 25% tranche by 2%. Given the seeming lack of agreement on this important aspect, this leaves both sides free to interpret as they see fit raising the risk of potential conflict. Fourth, each side has made commitments that are easy to reverse. China has made commitments to purchase US goods and services. It is not hard to shift purchases to other countries if they feel the US is not rolling back tariffs fast enough. US rolled back some tariffs. It is not hard to reimpose those tariffs if they feel China is not living up to its commitments. There is very little hard and fixed moves here raising the risk of cheating. Fifth, there is a clear asymmetry in that while the Trump administration is committed and invested in addressing what it sees as a real problem, the Chinese side openly resents the deal and US interest in addressing the problem. In other words, the Chinese side is not invested and committed to addressing the problem. That will be a major risk when expecting them to follow ambitious commitments.

Let’s turn now to some specific questions or criticisms of the deal that I have seen as it helps to place them in context and the tradeoffs.

Why is the US side insisting on specific import purchase targets from China?

Some unidimensional analysts have jumped on this push as the United States encouraging state control in China, but this willful blindness of the reality of dealing with China falls flat. China is and declares itself a state managed economy. The major sectors of imports, take agriculture for instance, are absolutely dominated by central state owned enterprises controlled by the government and CCP. It would be the height of willful ignorance to craft a deal dominated by central state owned enterprises and rely on market pressures and price competition to change behavior. As an example, for much of the trade war, China has actually rebated tariffs on US soy bean imports, but US soy bean imports still collapsed. In other words, based purely on price SOE importers had no reason not to buy US soy beans, but still did not. Market dynamics are irrelevant in this context. The entrenchment of Chinese state planners is semi-understandable, but the reality is China could easily do something like lower official tariff rates and still order firms to never buy US soy beans for instance. There is one other very important reason here that is largely overlooked. Much of the structural changes committed to by China will not be easily observable and even in the best of cases, reasonable people would have reasonable disagreements, and would take time to figure out commitment reliability. Import purchases are easily observable and verifiable. China clearly has no trouble changing SOE purchasing patterns if it chooses. The import targets are clearly an easy test of Chinese commitment. This is why I say, small regular or irregular misses of imports are unlikely to raise concern in Washington. Large regular misses are likely to rapidly raise concern in Washington. The Trump administration has long signaled a disdain for the complete failure to monitor agreements with China and re-escalate when cheating was obvious.

Second order effects are going to be very important. Very important

By second order effects, I mean what are changes that will be precipitated by these changes? For instance, what will happen if China meets its commitment on imports of US goods? There are two ways theoretically to accomplish this. Either increase total imports or keep imports relatively constant and displace imports from other countries. Given the hard currency shortage in China, the most likely scenario will be displacement of imports from other countries. There are a wealth of potential second order effects that could comprise there own lengthy speculative paper but this is something to watch out for.

This is a bad deal because it doesn’t contain more structural changes to China

This is partially fair and partially unfair. The Phase I deal grew out of the realization that China basically had removed all issues of substance from potential negotiation. China is basically refusing to negotiate broader more structural issues like industrial subsidies and import substitution policies. If we accept the logic that the Phase I deal is supposed to a more limited and narrow deal that sets the table for additional work, then the more limited nature of the deal seems a reasonable first step. However, this implies that there will be additional work to address other issues. Given that China refuses to discuss other issues and will likely be even less inclined in the near future to discuss them in the near future, I would set expectations for a near term follow up deal low. What this forces then is the expectation is that the Trump administration allow the Phase I deal to enter into force and verify commitments and then resume pressure on a variety of economic issues. This however potentially sets the table for potential failure or serious problem. The Trump administration, and Congress, is likely to resume pressure on China across a range of policy domains again in the first quarter. US is pressuring Europe over issues like Huawei and there is pending legislation on issues like financial flows to China and imposing sanctions on those involved in Xinjiang. Given the known Trump administration focus on following through on deal monitoring and viewing the deal as a Phase I rather than an end point, China is likely to be disappointed if the pressure does not dissipate.

What are the pressures on China?

China remains under enormous pressure economically and financially. Officially growth is around 6% and likely to remain so in 2020. Unofficially, most analysts put it at most as half that. Making significant structural changes to the economy under such economic pressures is unlikely given Xi’s well known focus on tightening political and economic control. Furthermore, despite officially high levels of reserves there is clear dollar shortage and large leakages that are raising enormous financial pressures on a country where trade is still enormously important. This makes meeting ambitious import targets all the more risky. Pushing significant structural changes and ambitious financial targets on China are going to cause significant pressure.

What is the final verdict on the deal?

If we take what is known about the deal, its role as a Phase I deal leading to later deals, and assume it gets executed as described, with each side living up to their commitments, I think it is fair to describe this deal as a solid step forward. Realistically however, each side seems to be positioning themselves for the expected failure of the agreement and little reason to believe the deal will be executed as described. The Trump administration has maintained significant leverage if China does not follow through on its commitments and I have little realistic reason to believe China will meet its commitments. At the end of the day in any contentious negotiation, it comes down to placing risk adjust trust in your counterpart to execute their side of the agreement. Each side is signaling they have little faith in their counterpart. If we start from that premise, the Trump administration seems to have positioned themselves well expecting this deal to eventually collapse but also lower tariffs if by chance China does abide by it commitments.

What are the Options Part III: The Bigger Picture

Posted on September 27, 2019 by Christopher Balding

What are the realistic options the United States has to challenge China? In part 1, I covered why the standard cliches about confronting China are unrealistic. Factors like the WTP, TPP, and working with allies are all good things and should be done but have little to no efficacy or impact on altering Chinese behavior and have a range of problems even in adopting them as strategies. Their ability to materially impact Chinese behavior is wildly oversold. Part II covered what is the general position of China specifically focusing on what type of conflict China believes they have entered vis a vis the United States and what there internal framework is for viewing the state of the world and how to proceed in the not a trade war trade war. Here we learn that China will be enormously resistant to any type of material change seeing it as fundamentally oppositional and dangerous to their entire systems of governance and something the Great Leader has sworn to avoid.

To date, the primary logical strategy here has been to eliminate strategies that are unlikely to be effective and lay the groundwork for why other strategies would be effective. Arguably the biggest problem with proposals about how to approach the not a trade war trade war is that well meaning people provide profoundly reasonable that are reacting primarily to Trump rather than thinking through the mechanisms and channels to induce material changes to Chinese economic policy (TPP, WTO, and allies do not), the internal framework with China, and the nature of the conflict. This does not mean many writers are unreasonable, it only means their motivation has been reacting to the President rather than taking the nature of the conflict and the adversary as the starting point. Tinged with a healthy amount of unrealistic assumptions about China and how to induce change and we are left with weak thinking about how to address the challenge posed by China.

Before considering specific ideas, we need two more points that lay the foundation of how I believe we should consider any idea about how to approach China. First, any strategy must be materially different from historical policy on China and demonstrate how it can mechanically produce higher quality outcomes given the criteria I have laid out in Parts I & II. For instance, many supporters of a WTO heavy policy to challenge China fail to demonstrate how it is materially different from pre-January 2017 policy or that if the US filed new litigation how it would result in significant change to Chinese behavior. Law suits were filed and the US won numerous cases against China and yet China became a more centralized, less free economy, with greater and more varied forms of national discrimination and non-tariff barriers. As another example, many have argued that the Trump administration simply needs to engage in more good faith negotiations with China to extract material changes in behavior. However, as they point to a myriad of agreements reached pre-2017 that were rapidly breached by the Chinese side and resulted in no net shift in Chinese behavior. This then falls back on them asking us to either trust them or utilize methods tried before that accomplished nothing. Any new strategy must be materially different from historical strategic policy and demonstrate how it can produce higher quality outcomes and not rely on a personality or individual skill. If one wants to rely on liberal international systems and allies to produce change, one must demonstrate that allies and systems have both the same focus and then the ability to produce change. Neither has been proven currently or historically.

On a quick tangent, one of the debates that has been simmering in Washington DC and foreign policy circles under a variety of different guises is the legacy defense of US foreign policy towards China pre-2017. Debates have focused on a variety of sub-issues such as whether China should have been allowed into the WTO and whether American diplomats were too optimistic that China would become a democracy. I think these are distracting tangential academic or legacy protection debates to the more policy focused fundamentals we should be worry about: in its bilateral and multilateral centered relations with China, was the United States successful in generally pushing acceptance of its values and policy aims? Since China entered the WTO, it difficult to see how the US attained broader acceptance of its values and realized material policy objectives vis a vis China. Put another way: US policy has not even achieved most of its aims compared to China leaving aside any discussions about whether China democratized. In saying this, we must note the difference between reaching an agreement and then having the agreement adhered to or following through with material policy moves even if not covered by an agreement. The US record with regards to China is one of significant failures at both the big picture framework and specific policy outcome level. The United States has not succeeded in pushing its values and has stood relatively idly by as China ignored bilateral and international agreements. The best that can be said of US policy with regards to China pre-2017 is that current critics do not have a record of success to point to in dealing with China.

Second, as a society we must have a clear recognition that challenging China carries with it significant costs. Any broad strategy that does not carry significant costs is not worth discussing as a reasonable framework. There are a couple of notes about this point. My use of the word “cost” here is very broadly defined. It may mean expending political capital, higher taxes and increased spending, revenue foregone by American businesses, and deadweight loss to the economy from higher import costs or supply chain moves just to name a few. Furthermore, given the pre-2017 strategy of investing little and imposing or accepting minimal costs in dealing with Chinese behavior, there was little reason for China or the United States to either change behavior or follow through on agreements. Lacking a cost absorption or imposition mechanism or recognition upon issues in dispute between the United States and China returns US policy to pre-2017 methods with no credible enforcement or punitive follow through measures render any demands or changes subject to the whims and fancies of the CCP. Based upon the historical record, it is not a credible strategy to rely on the benificience of Beijing to execute an agreement or on the personality of an American leader. Any agreement that is personality dependent is not an agreement. This renders any strategy that does not establish a plan to both absorb and impose costs at the outset if necessary not credible.

The challenging part is that this gives us a relatively constrained framework in which to move forward or analyze an agreement or policy options with China within a strategic or logical framework. We have eliminated as viable alternatives most of the common cliched strategies, largely eliminated most historical strategies, and imposed a hurdle for what constitutes a viable strategy going forward that it must include cost recognition with cost being broadly defined. This may sound constraining but I believe there is an important issue to clearly recognize. Significant changes to the international geopolitical landscape necessitate major shifts in foreign policy framework. We cannot adopt the historical frameworks of how to approach and deal with China and the broader geopolitical landscape. Adversaries and enemies have changed with alliances in flux and different countries being pulled between these competing centers. We need major new frameworks.

So before we turn to a more specific question of policy approaches let us sketch out some broad ideas that I think will then help guide our approach in laying out specific policy approaches in dealing with China.

First, the United States must take the leading role in promoting liberal international values including but limited to openness, democracy, human rights, free markets and trade, and rule of law. This may sound obvious but it is neither obvious to recent Democrats or GOP. Since the Obama administration, the Democrats and GOP have had overlapping lack of interest in using or projecting American interests or values abroad, albeit for different reasons with different motivations. The Obama administration famously called for “leading from behind” and the Trump administration has a distaste for international institutions believing they have failed in their missions which is not entirely wrong. Put another way, while the Trump administration may not like international institutions believing them broad failures, the Obama administration effectively operated a benign neglect strategy. While the Trump administration takes a strong inward looking approach to trade with regards to China, their approach has caused worry in numerous Asian allies. This differs from the Obama approach to Asia which was criticized for being non-existent outside of the public relations campaign on the Asia pivot. While they may have different motivations, neither the Trump or Obama administrations have been forceful and consistent international defenders of American values and promoting American values. For all the criticism the Trump administration receives on human rights and democracy promotion issues, the Obama administration was arguably even worse especially if the Trump administration takes concrete steps supporting Uyghurs and Hong Kong democracy. In reality, the thread of soft isolationism after the Iraqi War runs throughout both the Obama and Trump administrations. The United States needs to rededicate itself to being the global leader in promoting openness, democracy, rule of law, free markets and trade, and human rights in both bilateral and multilateral relationships and forums.

Second, we need to rethink what the United States wants and needs from institutions and alliances and how this evolution will need to play out in the brave new great power conflict with China. The United States is confronted, at the same time it confronts a rising expansionist authoritarian state intent on remaking the international order, with an international order of dubious strength, focus, and foundation. While these issues have come to the forefront under the Trump administration, he inherited institutions and alliances in an already seriously weakened state. The US-European alliance had been fraying for some time and to just pick one issue, the lack of any credible European military either at the individual country or on an EU wide basis had been a sore point for many years. Similar criticisms could be made of the UN Human Rights Council. With authoritarian human rights abusers gaining a critical mass that countries like China are keen to exploit, and the US has little ability to stop, the UN Human Rights Council has become a laughing stock. While the Trump administration decision to withdraw could reasonably be questioned, the UNHRC was anything but a well functioning institution that was meeting its original objectives and goals. Even the WTO had understandably been questioned by many for years before Trump over issues such as its weakness in dealing with countries like China to its unwieldy nature of trying to work in an institution where effectively every country has a veto which led to the Doha Round of trade negotiations which began in 2001 still dragging on. Institutional reform across a variety of multilateral institutions and bilateral relationships needs a rethink. The Trump administration inherited an international system that was already in a seriously weakened state. We need to seriously think about what we expect from international institutions and alliances in the new landscape.

Third, we need to think actively about how specifically to project influence and challenge China. For all the US talk about European allies not meeting their security commitments, the US has invested strikingly little in international development assistance. Furthermore, while the US still holds an enormous soft power edge over China or any other country for that matter, China has become quite skilled at exercising influence whether via state owned banks but influence directed from the state. While the US holds an enormous lead in pure soft power, think Friends and hard power think missiles, we need to think specifically about middle grounds of power and influence. One of the most common worries one hears from business and government is how to increase American business investment specifically into emerging and frontier markets that are being actively targeted by China under its Belt and Road Initiative. While the United States and Europe already significantly outpace China by existing stock of investment and even by ongoing flows in most countries, valid questions are being raised about to raise investment and influence. Typically, the US and other developed countries government have played a relatively minimal role compared to China in pushing investment into other countries. Left to the free market, many investors are loathe to accept a variety of risks that accompany investing in frontier markets, especially on longer term investment like infrastructure. What are ways that the United States can further spur factors like private investment abroad and specifically in emerging and frontier markets? What are channels for this middle type of influence or power to be used?

Fourth, we need to think about the costs the United States is prepared to accept going forward to challenge China. When I use the term costs, I mean it in a very broad sense from political to economic and others. However, despite facing an enormous task, there has been very little discussion of accompanying costs to challenging China. This is politically the most sensitive and under discussed foundation of everything we need to talk about with regards to challenging China. Simply from a strategic point of view, no thinker, negotiator, or diplomat can credibly claim to have a plan how to deal with China that does not incur significant costs. As a simple example, throughout most of the post China WTO entry period, the United States has avoided imposing costs upon China due to its non-compliance or misbehavior. Ex-administration officials will cite the agreements they reached but they will studiously avoid any talk of compliance. Lacking a credible threat to cost imposition from non-compliance gives China free reign to avoid complying with any agreement, something they have done repeatedly. Taken from another cost perspective, while we often like to think of the attractiveness of our values in swaying hearts and minds, cold hard cash is frequently a dominating factor with comic book tentpoles merely an accompanying factor or byproduct. If the United States wants to move public and private actors throughout Asia and Africa to at least not comply with China, we will need to invest significant hard financial resources. This may run the gamut from military assets to work with allies to secure the Indo-Pacific region to international development. Finally, costs may mean taking hard decisions or leading in new ways. For instance, given the many years of refusal to increase defense spending, it may mean shifting US military assets out of Germany towards other countries to face more direct risks. It may mean moving the focus of trade agreements away from the WTO towards other multilateral forums. It may mean using conditionality on development assistance to channel investment to countries building up democracies and running sound economic policies. This will require political capital to allocate financial and political resources by what we as a country prioritize. If we want to spread values like openness, human rights, and democracy, we will need to help countries that demonstrate a desire to establish democracies and aid them in that transition. That will also mean cutting off funds to countries that backslide or engage in abuses.

Throughout much of the post-China WTO entry, the US has been an unwilling or uncomfortable leader of the international liberal order. The post WWII order flourished because the United States made the largest sacrifices setting the tone and direction of negotiations, alliances, and international institutions. By binding itself to the institutions and agreements it created, which embodied a specific set of values, and pushing other states and signatories to comply, the United States compelled adherence to a globally recognized set of standards and values. The United States must be prepared to layout a vision for the value it wants to promote, to make the biggest sacrifices to realize those values, share the benefits with aligned countries, and deny benefits to adversary or nonaligned countries.

Balding's World

Global Finance and Economics