China Isn’t Playing Fair, And Neither Should We

Getting tough on China is becoming a popular idea. President Obama has established an Interagency Trade Enforcement Committee with a $27 million budget to hit back at unfair trade. Not to be outdone, Mitt Romney has said that if elected, he’ll declare China a currency manipulator on his first day in office.

It’s easy to understand why this sentiment has become so strong. Of course, politics is part of it, but it’s the smaller part. The main reason is the fact that a lot of unfair trade is being practiced in the global economy. There is no doubt, for example, that China is manipulating its currency in such a way as to favor its exports and to penalize imports.

It is also the case that companies like Intel and GE have, in some cases, moved production and R&D to China because China has indicated in a number of ways that if companies want to sell in China, they had better also be producing and doing R&D in China. Then there is the Chinese use of export tariffs to prevent critical materials like rare earths from being exported to foreign competitors. All of these policies and actions are in violation of both the spirit and the letter of the World Trade Organization (WTO) and/or the International Monetary Fund (IMF).

But getting tough in the usual American way by initiating some legal or quasi legal dispute-settlement action and threatening to impose anti-dumping duties or some other tariffs, surcharges, and fines not only is not going to work, it’s going to be counter-productive. It won’t work because the whole premise of the actions is false, and it will be counter-productive because it will engender retaliation — the fear of which will inhibit the cooperation necessary to make the case.

Let’s start with the false premise. It is the American notion that the U.S. and China should be playing the same free-market, free-trade global game in accordance with the rules of the WTO and IMF (to which both countries belong). In other words, there is no systemic difference between the two economies, and problems can thus only arise if someone is not playing by the rules. Under this premise, a penalty administered by an independent, outside body for rules infractions will halt the infractions and bring the market situation back into proper competitive balance.

This premise is wrong because America and China are not playing the same game. The United States is playing free-market free-trade capitalism while China is playing mercantilist state capitalism. Or to put it another way, China is playing football while America plays tennis and acts like China is, too.

Now here’s the important part. The U.S. keeps trying to show (in endless bilateral discussions) the Chinese how to hold the racquet, and when the Americans get tackled in the midst of their tennis lesson they scream: “Unfair play!”

Doing so is not going to persuade the Chinese to stop playing football. China isn’t playing football unfairly. It doesn’t go offside or clip or rough the passer. But football is a rougher game than tennis.

One problem here is that the rules of the WTO are so limited and have been unenforced for so long that mercantilists can honestly argue and believe that what they’re doing is free trade. Another problem is that the United States has acquiesced to the mercantilism practiced by Japan, South Korea, Taiwan, and others to such an extent that the Chinese can rightly feel discriminated against if Washington suddenly gets very picky about the rules.

But the main problem is that because China is operating a wholly different system that is integrated and coherent within its own framework, slapping the Chinese for an infraction here or removing a barrier there is not going prevent the proliferation of more infractions and creation of new barriers where old ones may have been torn down. It’s a whack-a-mole game. Furthermore, every time America whacks, China loses face and becomes more determined not to change course.

Because China’s bureaucracy has great discretionary authority, it can intimidate U.S. and other foreign companies and executives and thereby persuade them not to give the information needed by U.S. officials to prove unfair trade acts in the first place. So the bottom line is that conventional getting tough with China in a histrionic fashion is unlikely to yield anything good.

The Godfather had the right answer. Don’t get tough. Get even. Make sure China knows it’s “not personal; it’s just business” and then play tit for tat.

For example, Washington could pressure Chinese companies in a variety of ways to produce and do their R&D in the United States just as Beijing pressures U.S. companies to produce in China. Intel has just opened a Pentium Microprocessor fab in Dalian. This was done in significant part in response to continued pressure from the very top in Beijing for Intel to prove it is committed to China’s future. Well, perhaps Washington could pressure Huawei to prove it is committed to America’s future.

Or take the currency manipulation issue. Instead of continuing to whine about it Washington could impose countervailing duties or even an emergency tariff on imports from China.

It is important to recognize that in most of our trade with China, the assumptions of free trade (objective currency valuations; absence of economies of scale; perfect competition; full employment; no cross-border flows of technology, investment, and people; no economies of scale; etc.) don’t apply. Therefore, contrary to free trade orthodoxy, trade is not a win-win game. Rather it is a zero-sum game of win-lose. In that kind of a game, game theorists know very well that tit for tat is the winning strategy.

This post originally appeared at Harvard Business Review. It is part of the HBR Insight Center on American Competitiveness.

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2 thoughts on “China Isn’t Playing Fair, And Neither Should We

  1. I don’t really follow politics much or any of that, but I really don’t understand much of the anti- or let’s-play-super-hardball- on China sentiment…take the recent Iranian oil example (even though I’m def no expert on it): in an effort to show support to the U.S. China complied with not purchasing oil from Iran even though it’s a friendly to the country. Instead, India went in and scooped up all the oil at a super discount. But nothing was said to India on that matter. In fact, not only did India get a great deal and no bad rap, China wasn’t even shown the slightest bit of praise for its actions, and had it been China who had purchased that oil instead of India it would have gotten sooo much sh** for it. As an expat living here, it seems to me that China is trying very hard to please everyone yet never gets any slack and only gets more bad press in the U.S. I’m not saying anyone is right or wrong, just trying to understand…

    • Hi,thefobbymotherland.I appreciate your comment.I think you definitely got your point.But here is the thing:while China is leading the globle economic,something is being Ignored deliberately by the the ruling of Communist Party committee at each level,for example,the chinese water pollution,according to news report ‘about one third of the industrial waste water and more than 90 percent of household sewage in China is released into rivers and lakes without being treated.Nearly 80 percent of China’s cities (278 of them) have no sewage treatment facilities and few have plans to build any and underground water supplies in 90 percent of the cites are contaminated. ‘The goverment here plays a role people dont want to beleve:they use their power to stop environmental activists and journalists who wants to cover the fact,not letting people realize and take actions in order to have a world that less pollution.The China goverment has their reason to do that:sewage treatment facilities cost too much each year,they dont want to spend that kind of money because it’s irrelevant to them.Believe me,Chinese officers and factory owners are interested in profits only,they dont give a damn about what happened to the nature environment.Besides this wast water pollution thing is just one of all the unappreciated things goverment has participated.

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