Global Intelligence Series

Build Back Better? The Future of the US-China Economic Relationship

Date December 8, 2020
Speaker WEI Shang-Jin (Professor of Finance and Economics, Professor of International Affairs, and N.T. Wang Professor of Chinese Business and Economy, Columbia University / Former Chief Economist of Asian Development Bank)
Moderator SABURI Masataka (Director, PR Strategy, RIETI)

President Trump's trade and technology wars against China have on net created a lose-lose-and-lose outcome for the two countries and the rest of the world. Can the situation change to a win-win-and-win pattern under a Biden administration? This will require some fact-based diagnosis of the nature of the economic frictions. It may also require a different kind of bilateral discussions focusing more on structural reforms in China rather than numerical import targets, depoliticization of trade policies by all parties, multilateral efforts at WTO reforms, and considerations of trade and economic relations in a larger context of addressing major challenges to the global society including climate change management.



I want to speak broadly about three related subjects. First, I'd like to assess the effects of the U.S.-China trade war. Second, I will talk about China's trade conduct, especially since its accession to the WTO. This has some bearing on how future U.S. administrations might alter their approaches to China. Third, I will speculate on the future of the bilateral economic relationship.

U.S.-China trade war

Since early 2018, the Trump administration has progressively raised tariffs on an ever-widening set of goods from China, so much so that the U.S. tariffs on Chinese imports are currently roughly at the level of the Smoot-Hawley tariff in the 1930s. China has retaliated almost immediately. Smoot and Hawley were Republican members of Congress who in the 1930s who proposed to raise the US.. tariffs on imports very dramatically. Many economic historians blame the Smoot-Hawley tariff in part for causing the world economy to enter the Great Depression. When FDR was elected US President, these two congressmen lost their re-election bids and FDR started a wave of liberalization, starting with the reciprocal trade agreements. At this moment, with the Biden Administration coming to power in the U.S., we may also ask whether there will be a similar change in direction, and whether Biden will lift these tariffs and if so, how, and how quickly.

Starting with the effects of the trade war on China, my conversations with entrepreneurs in China have made it clear to me that most think the trade war is terrible for their businesses, even if they don't export to the U.S. Firms exporting to the U.S. directly are a relatively small percentage but almost all firms are affected by the increased uncertainty associated with the trade war.

The impact of a trade war is very heterogeneous across firms and potentially across regions. The overall effect is very negative for most businesses. It also depends in part on how the Chinese government reacts to the trade war. In recent months, the Chinese government has talked about the dual circulation strategy, partly as a way to deal with the risk of current and future trade wars. The idea of a dual circulating strategy is to pay more attention to the domestic market, domestic supply chains, and domestic innovation.

Impact of the trade war on the U.S.

It's clear that the trade war is very negative for China, but China's policy response limited the severity of the effects in China. In terms of impact on the U.S. economy, let us review a few recent research papers on the subject. The first looks at the effects of the trade war on prices in the U.S. You see relatively clear evidence of an increase in prices as soon as tariffs were imposed. Econometric analyses suggest that the increase in prices is almost one-for-one relative to the size of the tariff increase, so for every 10 percent increase in tariffs, you get close to a 9.6% or 9.7% increase in the imported price of goods.

When the U.S. raised tariffs, it wasn't obvious who would bear the burden of them. President Trump likes to suggest that the tariff is paid by the Chinese. In principle, at least, he believed that Chinese exporters would choose to respond to the tariffs by cutting prices. The higher tariffs are in principle partly borne by U.S. importers and eventually U.S. consumers and partly by exporters. The data suggests that for at least these first six waves of tariff increases, the overwhelming majority of the burden of the higher tariffs was borne by U.S. importers and therefore eventually by U.S. firms and finally U.S. households.

Similarly, as soon as a tariff was imposed, there was a decline in Chinese exports of the affected goods to the U.S. This declining volume means, of course, that Chinese exporters also suffer. Even though they didn't seem to cut their export prices very much, the volume of exports clearly suffered with the rising tariffs. First of all, U.S. demand for goods from China has declined. Second, it's just not as attractive for Chinese firms to focus on the U.S. market. In that sense, the trade war clearly has hurt people on both sides.

U.S. consumers also suffer because they now have a diminished variety of goods. Producers in the U.S. also see an increase in their prices because roughly 40% of Chinese exports to the U.S. are parts and components in other intermediate goods, according to the U.S. manufacturing and service sectors. This means that U.S. firms on the downstream side are now facing reduced competitiveness globally.

At least in the initial few months, U.S. retailers seem to absorb a big part of the tariff increase. They were reluctant to pass the tariff increase on to consumers initially. This is eventually unsustainable and households then suffer as well. The Chinese retaliatory tariffs seem to translate into a very visible decline in U.S. employment and income in certain regions, mostly through reduced U.S. exports to China. Looking at purchases of automobiles by U.S. households, which reflects households' perceived income levels, if households anticipate economic difficulties, they tend to cut down on purchases of durable goods like automobiles. Regions with more exposure to Chinese retaliatory tariffs show very sharp declines in sales of automobiles as soon as the Chinese retaliatory tariff is imposed.

If you look at how different regions were affected by Trump's tariff increases, you find that regions with a medium number of Republican voters seem to be most affected. What you also find is that the more Republican votes a region gets, the more likely it is to have been negatively affected by foreign retaliatory tariffs.

Effects on other countries

The effects on other countries are somewhat more complex. Some, like Vietnam, India and Mexico, might benefit from the U.S.-China trade war through increased exports to the U.S. High income countries like Japan and Germany might benefit from being able to export more to the Chinese market, displacing U.S. exports. On the other hand, there's also an unfavorable effect for other countries. Under the China Phase One Agreement, the U.S. has imposed a very high numerical import target for China. In order for China to fulfill this agreement, it would have to buy less from other countries, although we haven't heard many complaints from other countries, as they seem to want to avoid any worsening of their relationships with the Trump administration.

The other less visible but potential very negative side effect is that a trade war has normalized the weaponization of tariffs. It seems to show that it is okay to use tariffs to achieve non-commercial goals. That's potentially very negative for the world. This trade war also comes at a time when the WTO's dispute settlement functions have been severely undermined. For example, even when the WTO rules against the U.S. tariffs, the case will go nowhere because the WTO process is not very effective. The overall effect of the trade war is a losing situation for everyone.

Biden's approach

A new president means a reset opportunity for the bilateral relationship. Naturally, one needs to ask oneself what the U.S. and the Biden team really want from China. What reforms do we want to see? We also would want to know whether China is capable of making pro-efficiency and rule-based reforms and finally whether there is scope for collaboration. We want to see many structural reforms in China: greater discipline on industrial policies, subsidies, and state-owned firms, exchange rate and financial sector reforms, greater protection of intellectual property rights, a further reduction in trade and investment barriers and potentially more balanced growth models.

Is it realistic to expect to see progress on China? Starting with trade barriers since 2000, we have seen a very big decline in Chinese tariffs across all products over the years but they remain very high. By the time that China joined the WTO, it had become roughly comparable to other countries. As income has continued to increase, tariffs have progressively declined. The Chinese have today somewhere on the order of 8% tariffs on average.

There are three views on this. One is to look at China today compared with U.S. tariffs and Japanese tariffs outside the agriculture sector. Chinese tariffs were more than twice as high as U.S. tariffs before the US trade war. The U.S. trade war has managed to raise these substantially. Chinese growth is higher than that of the U.S. and most other high income countries, leaving more scope for reform. That's one takeaway. The other takeaway is that across the world, the average tariff level tends to be a function of national income. When comparing China to other countries of comparable income, the tariff level or level of trade protection is roughly what you would expect for a country at that level of income. In other words, it's not particularly protectionist. If you compare the Chinese market with something like the Pakistan market, the Indonesia market, or the Indian market, the Chinese market tends to be more open. The third takeaway is that we have seen a very rapid reduction in barriers. China didn't grow because it protected itself: it grew because it chose to liberalize, engaging in many pro-efficiency reforms. Chinese growth is not a counterexample to the textbook economics message. Rather, it's a confirmation of the message that the market is important. Therefore, this suggests that China is entirely capable of doing pro-market, pro-efficiency reforms and the Biden team needs to realize this. President Trump's Commerce Department just last week announced a new anti-subsidy case against a Chinese exporting firm, not based on any actual subsidy, but based on the argument that the Chinese exchange rate is substantially undervalued and that this is equivalent to a subsidy;:this is potentially a very dangerous precedent.

Protection of intellectual property and the WTO

On protection of intellectual property, there have been a lot of complaints about China's record on IP protection. It is true that China can make many improvements in this area. At the same time, using the IMF's balance of payments data and compare loyalty and fee payment to foreign patent and IP holders, Chinese IP fee payments based on objective data do not seem unusually low than other countries at similar incomes. As Chinese local innovation has been progressing over time, there are more local intellectual property rights to protect. Therefore, there is actually a lot of local demand for strengthening the IP regime. IP protection is not a hopeless thing for other countries to negotiate. There are good reasons to think that China is on a path to strengthening its IP protection.

Another issue that frequently arises is whether the WTO provides sufficient discipline and sufficient rules vis-à-vis Chinese trade policy and trade practices. The U.S. claims that China violates WTO rules left and right. We can assess this question using WTO's data on trading partners' complaints about one another on its website. Complaints by other WTO countries about the trade behavior of China, Chinese firms or China's trade policies make up roughly 12.6% of the total complaints. That's roughly proportionate to China's share of global exports. Moreover, there are fewer complaints about Chinese export practices than there are about the U.S. There have been 99 cases against the U.S. and 52 cases against the EU since 2001 compared to 44 cases against Chinese exporting firms. In other words, the objective data from the WTO does not support the idea that China stands out as an especially egregious offender.

On the flip side, does China complain excessively about other countries' behavior to overwhelm the WTO process? WTO data actually shows that China is much less likely to bring a complaint than its import share would suggest. Finally, in terms of compliance with WTO rulings, virtually no large countries have a perfect record. In particular, neither China nor the U.S. has a perfect record. If a country finds it necessary to relitigate an issue against a country repeatedly, it might indicate that that the country did not comply with the WTO's ruling after losing a case. If you use that as an indicator of non-compliance, data suggests more non-compliance cases by the U.S. than by China. The summary of this discussion is that in terms of compliance with global trading rules, China is also not a hopeless case.

There are many improvement needed in China's trade policies and practices. The cross-country comparisons using the WTO data suggest that China will likely make improvement as it becomes more developed.

Leveraging the tariffs: Structural reform and climate change

China's recent pledge to achieve carbon neutrality by 2060 is an interesting development. It goes beyond China's pledge in Paris, and also coincides with President-elect Biden's interest in reviving global climate negotiations, which he hopes will be under the leadership of the U.S. This provides an interesting potential area of collaboration between the two and with other countries as well. President Biden's team may very well try to leverage the lifting of the tariffs in place to extract reforms and policy changes from China. They are also very likely to focus more on structural reforms in China and less on numerical targets. Finally, given that Biden has said that climate change is a priority for him, his team may look into converting the tariffs into carbon tariffs to use them for the greater good of climate change management.

China is the largest carbon emitter overall, but U.S. emissions are twice as high on a per capita basis. China is transforming and becoming less carbon-intensive due to structural transformation. The new carbon neutrality pledge sees China making more progress towards renewable energy and reforestation. The problem is that the carbon intensive consumption pattern around the world has not changed fast enough. The world's consumption bundle is still very carbon-intensive. Today, China produces a big chunk of that bundle. But if China is not doing it, other countries will pick up the slack in the carbon intensive production unless the global carbon consumption declines dramatically. Just having carbon neutrality in Japan, the U.S., etc. will not be enough. Other countries will become the leading producers and it will be carbon-intensive production. To hold China to its promise, we have to make it expensive for them to reverse their pledge. We also need to make sure that other developing countries will not simply produce what China used to produce. One way to do that would be a global carbon tariff, not as a protectionist tool but as a carbon-neutrality incentive. It would raise the cost of producing carbon-intensive products anywhere in the world and the cost of consuming them. It would be a fundamental alteration of incentives. This is an area where cooperation among China, the United States, Japan, and the European Union can be very helpful.

The carbon tariff would need to be complemented by other policies. We would also need to offer financial assistance to developing countries to help with the adjustment to a carbon-free world. We might get carbon-neutrality for all high-income countries by 2050, most middle-income countries by 2060, and all countries, including developing countries, by 2075. This is still not easy or guaranteed. The carbon tariff would be a useful input into this and that means that there is potential for collaboration between the US, China and other countries.


The trade war has created a lose-lose-lose situation for China, the U.S. and the rest of the world. China's record of removing trade and investment barriers and on IP protection seems quite different from the typical media reports and very strongly negative U.S. rhetoric. China has shown it is capable of genuine pro-market, pro-rule reforms. The future relationship between the two countries may need to focus more on structural reforms in China and less on numerical import targets. With the new administration in the U.S. and with the recent carbon-neutrality pledge, joint work between the two and with other countries for a carbon-free world now holds new promise.


Q: How will the trade war and COVID-19 transform global value chains? What is the future of global value chains, especially in East Asia?

WEI Shang-Jin:
One effect of the trade war and the pandemic on the supply chains has been a lot more talks about more resilience and less emphasis on efficiency. Resilience can be considered a type of long-term efficiency. A certain amount of supply source diversification enhances robustness, resilience and therefore long-term efficiency. The risk to the world is that we could overdo it. Japan, the U.S. and other countries are talking about reducing dependence on China, while Chinese leaders are likewise talking about a "dual circulation strategy": reducing China's dependence on the U.S., Japan and other economies. If every country does that, the world might very well end up in a much less efficient arrangement, resulting in increased production costs, higher consumer costs, reduced real household incomes and an unwinding of some of the benefits of globalization from the last few decades. In other words, we need to manage the trade-off well between efficiency and resilience. Good management of the trade-off may require global coordination and a greater role by organizations like the WTO. If individual countries pursue their own resilience strategies, the result may end up being less efficient. This makes the case for reforming and strengthening the WTO so the whole world will be able to achieve a better balance between resilience and efficiency.

Q: Do you think China is ready to join the TPP and should Japan invite China to join it? Will Biden return the U.S. to the TPP?

WEI Shang-Jin:
First, the TPP has more requirements than RCEP, including on disciplining state-owned firms and on state subsidies. In that sense, if China were to join the TPP, it could become a way to induce more reforms. China has said that it is interested in joining CPTPP, suggesting that they may be willing to consider the relevant policy reforms.

China's accession to the WTO in 2001 has triggered a wave of reforms. These reforms were considered politically and economically difficult at the time, but are generally considered now to have contributed to the efficiency improvement and productivity increases. By the same logic, some in China may view membership in the TPP and the additional reforms this would trigger as a net good. Many Chinese entrepreneurs and reform-minded government officials may also think that TPP membership would make it harder to reverse those reforms. It is interesting to note that the Chinese top leadership recently said that they are interested in joining the TPP.

On the other hand, whether the U.S. would rejoin the TPP is a big question. Biden's team may have an interest in joining the TPP given his history in the Obama administration. However, the Democratic Party as a whole tends to be less interested in trade. Both parties may have become even less interested in these trade agreements over the last four years. This makes the prospect of the U.S. joining the TPP less obvious. I think it would be good for the U.S. to join. Having the TPP is better than not having it for TPP members, including Japan. Being a member of both the TPP and RCEP is wonderful for Japan, but neither the TPP nor RCEP is good enough because we live in a world of global value chains. Japan, China and the U.S. are important parts of global value chains across many sectors. Any regional agreement that excludes any of these three countries has the potential to artificially make some of the world's most efficient firms less competitive within the regional agreements. You're going to rearrange either regional trade, regional supply chains or global supply chains in less efficient ways because truly global and efficient producers are not part of either RCEP or the TPP. There's a need to expand both agreements. Eventually we want to see both the U.S. and China enter these agreements and see the agreements expanded. If those agreements are able to encourage China to increase its structural reforms, as they have in the past, all the better.

YANO Makoto (RIETI Chairman):
First, China is an extremely large country. What do you think is China's responsibility toward world stability?

Next, this trade war and this situation was started by the Trump administration. I think the Biden administration needs to do a lot of course correction, and I think we should think about how we can develop better global relationships.

Lastly, the Trump administration's foreign policy had geopolitical advantages for China as well as Saudi Arabia and Turkey, among others. They were able to expand their regional influence. I feel that we should seek to rebuild the 2016 status quo ante both economically and geopolitically. I would like to hear your opinions on this.

WEI Shang-Jin:
These are excellent comments. Let me start with your second comment, which is about how the Biden administration should deal with Trump's legacy. Biden's team clearly disagrees with President Trump's objectives and tactics. On the other hand, they will unlikely go back to the status quo pre-Trump. They will certainly choose a different goal because they have different priorities in mind. The Biden team knows that the world they are inheriting is different from that of 2016. They will want to ask whether they should lift Trump's tariffs for free or try to extract some concessions from the other side for doing so. I think the Biden team will very likely conclude they should get something in return for giving up Trump's tariffs, perhaps including more climate pledges from China.

Your first point about the size of China and its corresponding responsibilities is also very important. I think unless China experiences a major disaster, it is on a path to continue to grow. China may not achieve the same income level as the U.S. on a per capita basis, but surpassing and even doubling the U.S. in economic size is a high probability event because it only requires China to reach half of the U.S. per capita income. It will be much better for the world to have a set of global rules that China can be persuaded to think that it is in its interest to maintain.

The trade war has achieved the opposite result so far. In the last four years it has gradually reduced the ranks of those in China supporting global rules because they view the outside world as very hostile. We need to empower those in China who view the pro-market approach to be good for China and good for the world. President-elect Biden certainly has a chance to achieve that. Japan can do a lot too by helping to nudge China to play a productive role. Inviting China to negotiate for membership in CPTPP could be a useful step. I think Japan and the U.S. potentially can also participate in the AIB and the BRI program to help to ensure that those projects are corruption-free and environmentally friendly.

Your last point is related to the extent to which the U.S. has vacated its leadership position in many arenas. The U.S. needs to re-engage, certainly with global bodies, and other countries can also play a role. I think China is not necessarily averse to this. Many in China view China as a beneficiary of the global system. They've publicly stated that they want to improve the rules rather than replace or eliminate them. I think the potential exists for a good negotiated outcome.

WATANABE Tetsuya (RIETI Vice President):
You mentioned that the Biden administration will probably focus on domestic issues first and that not many constituencies are pro-globalization. Do you have any advice for the new administration on how they can convince their constituencies of the benefits of engaging in globalization and the global trading system?

WEI Shang-Jin:
The president-elect's supporters need to see concrete and easier-to-understand examples of gains from globalization. Right now, the appetite for globalization is not very strong in the U.S. People, I think, do not understand that the U.S. has been as much a beneficiary of globalization as Japan and China. Many voters don't see it that way. The Democratic Party under President Clinton was very pro-globalization. Now many people think President Clinton was too pro-globalization. Many people think that many Trump's voters in 2016 were supporters for Clinton but became disillusioned by Clinton's support for NAFTA, etc.

Even though the U.S. population as a whole clearly has benefited from globalization, the main problem is that the social safety net is not very generous, so adjustment to structural changes resulting from either globalization or technology is not as smooth as it could be. Each time you have a big shock, either from globalization or from technology, it tends to create a segment of society that feels that they've been left behind. Many feel like that the political elite has abandoned them, and some found hope in Trump. The Biden administration has a chance to engage in policy reforms that can help address this. Doing this would result in a more positive attitude toward globalization.

The necessary reforms need to go beyond more welfare programs or a higher minimum wage. It will also be important to upgrade the education level of the U.S. labor force. The data shows very clearly that when the U.S. expands its global economic engagement, better educated people are the beneficiaries. Some less educated people feel like they have been left behind and the local safety net is inadequate. Raising the skill level of the labor force would increase the fraction of the population that could benefit from globalization, giving it a stronger base of support for future liberalization. This would also enable the Biden administration and future U.S. administrations to be more open to further globalization. I think Japan should invite the U.S. to rejoin the CPTPP.

Q: The U.S. trade policy uncertainty index is five times higher today than it was between 2013 to 2015. The Japanese trade policy uncertainty index also rose from 2018 to 2019. What implications does this have for the U.S./China trade dispute under Biden and China's structural reforms?

WEI Shang-Jin:
Uncertainty has a very big impact on economic activity, including firm investment. Research papers have shown that it negatively affects investment and growth. Trump was a master at creating policy uncertainty not only for households and firms but also for the officials in his own administration. The typical government official didn't know what the U.S. policy would be next week or next month. I assume they lived in constant fear. We saw an unusual amount of uncertainty over the last four years, and therefore it is reasonable to expect that a new president will mean a marked decline in policy uncertainty, at least from the U.S. administration. That will be good news for the business community. More predictability from the US side can also aid policy reforms in China.

*This summary was compiled by RIETI Editorial staff.