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Could China end the trade war?

While it’s easy to become lost in the tide of tit-for-tat of policy measures, manoeuvrings in the US-China trade war can reveal key elements of China’s development strategy and the pragmatic mindset that pervades it, Daniel Poon writes.

Despite reaching an initial trade truce to start the year, recent measures by the Trump administration – particularly those aimed at financial markets – have raised concerns that tensions between the United States and China could escalate into a new type of Cold War.

Although comparison to the Cold War is a stretch at best, the matter is a serious challenge to China’s policy practice of shaping economic reforms in such as way so as to retain and expand degrees of autonomy over national policy decisions over time.

The overall outcome of the trade conflict remains unknown, but this is not the first time Beijing has had to conduct its decision-making under high levels of uncertainty. In fact, the twists and turns of the trade conflict may represent a rare opportunity to better understand the strategic mindset underpinning China’s development model.

Grasping a new policy mindset, while shedding some light on the directions and possible outcome of the trade conflict, can also be broadly instructive for other latecomer countries seeking to forge their own path to development, the way China has.

Autonomy in policy-making, also known as ‘policy space’, generally refers to the effectiveness of national policy instruments in achieving national economic and social policy objectives. That China benefited from engaging the global economy largely on its own terms, has become widely accepted. But how it has done so – and the strategic mindset shaping its policy approach – is often overlooked.

In the 1990s, the idea that Chinese industrial policies would foster economic prowess in key competitive industries, let alone in a range of next generation technologies, was deemed far-fetched. That China would later influence norms in global economic governance was inconceivable.

In the ensuing decades, the country’s industrial base has broadened and deepened, yet policymakers remain conscientious about the need to actively guide the upgrading of national innovation capacities.

A restructuring of global production chains in response to the COVID-19 pandemic has reinforced policymakers’ desire to balance greater economic openness with the localisation of strategic industrial parts and components, and China has been no exception.

With regards to trade negotiations, China has cautiously engaged with successive efforts to formulate new global rules that could restrict the ‘policy space’ of emerging economies like its own. This includes efforts to resist, delay, or adjust demands and pressures for stronger disciplines in the areas of investment, services, intellectual property rights, anti-trust, and state-owned enterprises.

In mid-May, the main United States federal government retirement fund, the Federal Retirement Thrift Investment Board (FRTIB), postponed a shift to an index fund that purchases equities in Chinese companies.

The decision followed warnings by the Trump administration that such portfolio investments could be exposed to the risk of future American sanctions against China related to the COVID-19 pandemic or for other national security or humanitarian reasons. In July, similar warnings were sent to the Railroad Retirement Board, a federal agency that manages pensions for retired railroad workers.

More financial-related measures are in the works, such as tightening accounting rules that could force some Chinese companies to delist from American securities exchanges, and the removal of special trade status for Hong Kong – a move that could threaten the city’s role as a capital-raising financial hub.

As with other measures, the FRTIB decision is aimed to create a ripple effect beyond the entities directly implicated. By sending a negative signal about Chinese equity markets, the Trump administration hopes to influence the behaviour of global investors. From a Chinese perspective, however, heightened awareness of a new financial front of the trade conflict came as early as August 2019, when the United States Treasury branded China a ‘currency manipulator’.

In one article, Chen Yuan, former governor of the China Development Bank and a key reform architect, considered the currency designation as marking an upgrade of the ‘trade war’ to a ‘financial war’ with greater global and long-term implications.

Noting the impact of exchange rate policy to economic growth, Chen invoked the experience of Japan with the 1985 Plaza Accord, which, in forcing a rapid revaluation of the yen, set Japan’s economy on an uncertain path in its lost decade of the 1990s.

Although the currency designation issue was dropped prior to the phase one deal, at the time, Chen outlined a calm but pragmatic approach in dealing with unilateral American actions. He also foresaw that foreign exchange market sanctions were only the start of a deeper ‘currency war’ that could easily lead to additional measures that restrict bilateral investment and financial flows.

In the short and medium term, he suggested that China maintain rational policy stances, while avoiding direct confrontation that would further escalate of American financial market sanctions and penalties.

This would involve bringing China’s exchange rate management regime closer to international practices and market rules, but also the need to be ‘highly vigilant and fully prepared’ to minimise negative economic impacts and ensure that wider financial sector decoupling ‘cannot be realised quickly or completely’.

In the longer term, Chen conceded that weaponising China’s foreign exchange reserves could have its uses, but it is ultimately a limited tool in a financial confrontation. Instead, gradually reducing the structural reliance of China’s economic development on the dollar would neutralise the United States’ capacity for waging financial warfare.

Reducing China’s reliance on the dollar largely entails gradually raising the international role of the renminbi (RMB) and expanding into new areas of ‘development space’ that would reduce American bargaining leverage. Part of this experimentation process includes, for example, recent inaugural domestic RMB bond issuances by both new China-backed multilateral development banks.

Chen, for his part, emphasised the creation of channels for RMB circulation in international commodity and futures markets. He highlighted oil, natural gas, iron ore and some agricultural goods as good places to start, along with increasing the use of renminbi in international trade settlement.

Overall, it is the belief of some Chinese policymakers that a calm and pragmatic approach can allow China to improve its standing in the conflict and gain the moral high ground in winning over greater international support.

While some may be hesitant about supporting or adopting this kind of strategic mindset, they may ultimately be ‘doomed to choose’, especially if waging trade wars becomes the norm for the world’s great powers in dealing with emerging states that dare to challenge their economic might.
Source: Policy Forum

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