U.S. – China relationship

Pascal Lamy’s recent comments on the challenges facing the WTO

Pascal Lamy is a former Director-General of the WTO (2005-2013) and former European Commission Trade Commissioner (1999-2004). He is President emeritus of the Jacques Delors Institute. As one would expect, he is a frequent speaker on trade matters. Two events in the last several months presented some thoughts on the challenges for the WTO moving forward.

Mr. Lamy was interviewed by the Lowy Institute in Australia in early July on their COVIDcast addressing the future of globalisation. See The Interpreter, July 3, 2020, COVIDcast: The future of globalisation, https://www.lowyinstitute.org/the-interpreter/covidcast-future-globalisation. Similarly, on June 17, 2020, he and Robert Zoellick (former President of the World Bank and former U.S. Trade Representative) participated in a Peterson Institute for International Economics Trade Winds program, What future for the global trading system?, https://www.piie.com/events/what-future-global-trading-system.

Below are some of my notes on points made by Mr. Lamy I thought were of interest along with my commentary.

globalization vs. deglobalization

On the future of gobalization, Mr. Lamy is of the view that the next few years will be a period of more obstacles for trade and investment. These obstacles will change the speed of globalization but won’t lead to broad scale deglobalization. There will be some onshoring to address fragility of supply chains. However, the clamor for onshoring will be “more bark than bite”.

In the United States both the Administration and parts of the Congress have called for onshoring production of medical equipment. There has been some utilization of the Defense Production Act by the Trump Administration to get producers to use facilities to produce needed equipment. Many U.S. industries and unions have urged the government to take action to permanently reshore production of various medical equipment. See Joint Statement on Policy Objectives for Reshoring and Safeguarding Domestic PPE Manufacturing (embedded below).

joint-statement-of-reshoring-of-PPE-production

However, the U.S. has not entered into long-term contracts to support significant reshoring efforts, possibly supporting Mr. Lamy’s prediction of “more bark than bite”.

precautionism

Efforts by countries to recover from the economic damage caused by COVID-19 will be complicated by what Mr. Lamy called “precautionism” (governments protecting people from risk) and which he distinguished from protectionism (protecting producers from international competition). In Mr. Lamy’s view, protectionism can be addressed by eliminating restrictions or other obstacles. Precautionism involves risk profiles which will differ among Members and possibly may differ among issues being considered and hence will be much more difficult to address to achieve a level playing field. Mr. Lamy in the Trade Winds program used the example of the tourism sector which has been devastated by governments’ efforts to control the spread of COVID-19 and noted that there are a number of different initiatives by countries to get some reopening of tourism (e.g., nonessential air travel) between particular countries, but that there isn’t a common approach which in his view reflects differing risk profiles of countries.

I would note that precautionism is not limited to the response to the COVID-19 pandemic. The WTO’s Sanitary and Phytosanitary Agreement and the Technical Barriers to Trade Agreement both recognize the right of Members to take measures to protect their populations at such level as is deemed appropriate by the Member although encouraging use of international standards.

To the extent the aftermath of the COVID-19 pandemic is a more cautious risk profile for major trading nations, recovery will likely be slower and more fragmented.

Borrowings during the pandemic to lessen the economic collapse

Mr. Lamy made several points on the massive amounts of stimulus funds being provided by certain governments to limit the economic challenges being faced from efforts to slow the spread of COVID-19.

His first point is that the size of the government programs will necessarily distort trade and create a playing field that is not level. Rescue plans for companies or industries, subsidies provided, increased state ownership are all elements of the distortions that he sees occurring. He believes countries will have to come to grips with the emergency needs and see that markets return to their proper role with reduced government involvement.

The second point is that only a few countries are positioned to provide this type of financial assistance because of the inability for most countries to borrow huge amounts of money for such stimulus activities. Hence the north-south divide is growing according to Mr. Lamy. While this point is certainly true, multilateral organizations like the IMF and World Bank and regional development banks are working to provide debt forgiveness and other financial assistance to some developing and to least developed countries to provide some greater flexibilities.

WTO reform — U.S.-China tensions

Mr. Lamy views the WTO as weaker today than it was ten years ago. He attributes the main source of the weakened situation of the WTO to the growing divergence between the United States and China. In his view, the tension between the two has prevented convergence on a range of issues.

Because the world has changed so much over the years, the WTO rulebook must be updated. China’s state capitalism economic system is creating significant problems for the world trading system. China’s trading partners are concerned about the high level of state ownership (30% for China) and the government support to the state-owned sectors. These facts lead to conflict with partners both in terms of market access in China and in terms of Chinese competition in other markets. Mr. Lamy notes that the WTO’s rules on state aid are weak. He doesn’t believe one can coexist with China in the WTO if rules on state aid are not toughened (what he describes as achieving “competitive neutrality”). Even with new rules, the geopolitical rivalry between the U.S. and China will remain.

Mr. Lamy agrees with the United States that the current WTO rules do not constrain China’s state capitalism practices which distort competition. He believes that China was making good progress on moving towards a market economy until the 2008-2009 financial crisis. China had lowered state ownership to 15% of the economy. With the financial crisis, China poured huge sums into the economy, including through state-owned enterprises. With the change in political leadership, the country shifted away from a convergence model and has continued to bolster its state capitalism model, now 30% of the economy. For the foreseeable future, the WTO will not be able to achieve convergence by China to a market-economy model, but will have to work on whether coexistence can be made to handle at least many of the distortions.

The Untied States has been pushing the WTO to come to grips with the fact that the WTO set of rules was created for market economies, and to recognize that such rules don’t work for large state capitalism economies. One of the WTO’s Deputy Directors-General, Alan Wolff, in a speech earlier this year, in reviewing principles that undergird the WTO identified convergence, not coexistence, as one of the core principles. See DDG Wolff: “There can be no permanent retreat from what has been created,” 10 June 2020, https://www.wto.org/english/news_e/news20_e/ddgaw_11jun20_e.htm (“Of necessity, the WTO is about convergence, not coexistence”)

In his comments during the Peterson Institute’s Trade Winds webinar, Mr. Lamy indicated that coexistence is possible if there are strong state-aid rules and reviewed the ability of Germany and France to work together in the EC despite France having had relatively high state ownership (around 15%) in the early years. The ability to work with a country with significant state-control was due to stringent state aide rules. The U.S., Japan and EU have been working to pull together improved disciplines on industrial subsidies, action that China has already indicated it will not accept. Mr. Lamy is of the view that China can be brought to the table by parties seeking “competitive neutrality” and by indicating to China that China will not gain additional market access without agreeing to new rules on state aid.

In a post last week, I reviewed an opinion piece by Peter Carl, a former EC Director General for Trade. His take on the same situation was that the EU, US and others should pursue improved disciplines on state aid but when such efforts are rejected by China, the EU and others should leave the WTO and start a new organization without China where convergence would be possible. See July 25, 2020, A new WTO without China?  The July 20, 2020 Les Echos opinion piece by Mogens Peter Carl, a former EC Director General for Trade and then Environment, https://currentthoughtsontrade.com/2020/07/25/a-new-wto-without-china-the-july-20-2020-les-echos-opinion-piece-by-mogens-peter-carl-a-former-ec-director-general-for-trade-and-then-environment/.

Mr. Lamy also reviewed how a functioning WTO is very important for developing and least developed countries. Trade and investment is a big lever for such countries in their development efforts. Thus, if the WTO continues to weaken, it is these countries that will be most hurt. Similarly, these same countries are likely most adversely affected by the trade and economic fallout from the COVID-19 pandemic.

WTO agenda

During the Peterson Institute’s Trade Winds program in June, Mr. Lamy indicated that proponents of open trade were in for a difficult time. He listed five issues of concern. Three were dealt with above (precautionism, government infusions to address COVID-19 pandemic, deglobalization/onshoring). He also reviewed the weaponization of trade, citing both the Trump Administration’s actions and the dispute between Japan and the Republic of Korea, and new forms of protectionism citing investment controls and new instruments.

Mr. Lamy believes that the WTO agenda needs to be looked at in two stages. The first or short term involves finding a new Director-General, and needs to include a cooling down period. My understanding of the cooling down period is to have governments who have poured trillions of dollars into their economies back out of such increased state involvement and permit reestablishment of a level playing field. This period will be a few years and will permit some increase in trust through small steps. He believes there will be a coalition for open trade and that the EU will be the leader depending on the outcome of the upcoming Presidential election in the U.S.

Longer term, Mr. Lamy believes that the WTO must go back to dealing with the big problems:

coexistence with China as long as China has 30% of its economy state-controlled; will require improved rules on state aid;

dealing with the trade and environment nexus; issue keeps rising on the global agenda; EU planned global carbon tax will be important issue;

around the challenge of precautionism, the world will need a new effort to level the playing field possibly similar to prudential rules in the finance system.

EU role in the WTO during the US-China tensions

The EU is serving as a stabilizing force in the WTO. Indeed, the more U.S.-China tensions increase, the more the EU will step in to provide stability. Mr. Lamy states that many WTO members want the EU to be a shield to protect them from having to pick sides with either the U.S. or China. This is a big role for the EU. If EU comes out of the COVID-19 pandemic stronger, it will bolster the role that the EU can play in the WTO to maintain stability.

Mr. Lamy cited the Appellate Body crisis as one where the EU by creating the multi-party interim arbitration agreement took the lead to maintain stability in the organization and got many countries to follow.

Conclusion

Mr. Lamy paints a picture of a challenging time for the world trading system in the coming years. He agrees that the WTO rules do not adequately address distortions that flow from China’s state capitalism economic system. His proposed solution is to coexist but work on obtaining stronger rules on state aid. While the U.S., Japan and the EU agree such improved rules are needed, there is a certain irony in his recognizing the need for stronger rules on state aid, as it was the EU, among others, who pushed for weaker subsidies disciplines during the Uruguay Round.

Mr. Lamy also paints a bleak picture of distortions created by countries’ efforts to stem off economic collapse as countries impose shutdowns to try to control the COVID-19 spread. His argument is from 30,000 feet and is conclusory – the introduction of such huge amounts of money necessarily distorts competition. My own view is that while the question of whether there are distortions is an important one, large parts of the funding don’t increase manufacturing or production but rather form a safety net under employers, employees and state and local governments dealing with an extraordinary situation that doesn’t reflect market forces. Of more use would be agreeing on identification of outcomes that are viewed as distortive versus those outcomes which simply offset the economic fallout from the pandemic. Many industries will end up much smaller after the pandemic than before and any rescue funds provided will reflect an effort to address the extraordinary event of governments mandating closure of markets. Presumably such funding should be agreed to be nonobjectionable. Whereas if an industry in a country expands with government assistance to take advantage of the closure of competitors because of restrictions flowing from efforts to address the pandemic, presumably such subsidies would be problematic.

The longer term issues Mr. Lamy raises will certainly take center stage at some point, but his list does not include any of the large number of pending issues before the WTO where progress will hopefully be made in the coming next year or so – fisheries subsidies, electronic commerce, etc.

What is clear is that the next Director-General will face a very challenging landscape with fundamental differences among many Members that will make forward movement by the WTO and its Members a challenging undertaking.

U.S. Withdrawal from the World Health Organization and Decision to Revoke Preferential Treatment for Hong Kong — Reduced Cooperation as COVID-19 Pandemic Rages on

On May 29, 2020, President Trump indicated that the United States was withdrawing from the World Health Organization (“WHO”) because of the WHO’s failure to adopt reforms the U.S. had demanded and the belief of a bias within the WHO towards China and China’s failure to provide timely information on the start of the virus and the likely nature of the problem. https://www.nytimes.com/2020/05/29/us/politics/trump-hong-kong-china-WHO.html. This followed the U.S.’s earlier temporary withholding of funds from the WHO while awaiting developments on reforms.

President Trump also indicated that in light of actions by China to assert security controls over Hong Kong, the U.S. viewed China as violating its commitment to maintain “one China, two systems” and would accordingly be taking actions to remove special treatment provided Hong Kong in a wide range of areas (extradition, export controls, etc.) and would be treating Hong Kong as part of China for tariffs, export controls, etc. https://www.wsj.com/articles/u-s-to-cancel-visas-for-some-chinese-graduate-students-11590744602.

Not surprisingly, China has reacted negatively to the statements of President Trump on Hong Kong and has threatened to take retaliatory actions if the U.S. takes actions contrary to China’s interests and indicated that any U.S. action was doomed to fail. https://www.bloomberg.com/news/articles/2020-05-30/china-says-us-action-on-hong-kong-doomed-to-fail; https://www.cnbc.com/2020/05/30/china-says-us-action-on-hong-kong-doomed-to-fail.html.

Concerns have also been raised that U.S. action would be a double-edged sword in light of the large trade surplus the U.S. has with Hong Kong and the enormous presence of U.S. businesses in Hong Kong. For example, based on U.S. Census data as compiled by the U.S. International Trade Commission, the United States had a trade surplus with Hong Kong (total exports – general imports) of $26.086 billion in 2019 [the trade surplus based on domestic exports – imports of consumption being lower at $11.845 billion]. While China has not identified actions it is considering, harming U.S. interests in Hong Kong would obviously be one avenue China might take.

The trade implications, in terms of U.S. imports from Hong Kong, are relatively minor. If imports from Hong Kong are treated as imports from China, imports of items subject to additional duties from the 301 investigation would be relatively minor. That is because U.S. imports for consumption from Hong Kong in 2019 were just $4.646 billion, with half of that being under HS 9810 for articles that have been imported after exportation, after repair, etc. If China were to impose additional duties on U.S. exports to Hong Kong, the effect would be larger. U.S. domestic exports to Hong Kong in 2019 were $16.491 billion.

Increased tensions; reduced cooperation

Whatever the merits of the actions being taken by the United States (and the reactions anticipated from China), the results are predictable — we are entering a period of reduced cooperation and coordination of actions to address the pandemic as well as increasing bilateral tensions between the U.S. and China at a time of global economic contraction. This despite the fact that cooperation has been less than robust even before the current increased tensions.

In the trade arena, the pandemic continues to grow in severity as confirmed cases continue to climb globally with the hot spots shifting. Cooperation at the WTO and G20 is critical in terms of keeping markets open, minimizing export restraints, addressing logistics needs in a manner that preserves the health needs of importing countries, avoiding inventory builds of agricultural products, the introduction of export restraints where there is no underlying agriculture production problem globally, taking actions to expand production of medical goods to meet the demand surge flowing from the pandemic, ensuring transparency, and promoting best practices. The world is struggling already to achieve the trade needs identified above. Reduced cooperation will make the challenges that much harder.

Similarly, the search for vaccines, therapeutics and diagnostics to effectively prevent, treat and identify medical needs requires global cooperation, information sharing and the work of a multilateral institution like the WHO and various NGOs to ensure all peoples who need these products have equitable and affordable access to them when developed. Trials on potential vaccines are at various stages in China, in the United States and in Europe and possibly other areas. Often the research is amongst companies working jointly from multiple jurisdictions. Which research project or projects will prove effective, if any, is obviously not known. Implications of a lack of cooperation between countries should effective vaccines, therapeutics and diagnostics be developed are for the possible hording of products, refusal to sell to other countries or delays in sharing and other actions that would make global escape from the pandemic harder, longer and more deadly.

And for many developing and least developed countries, the pandemic, whether significantly affecting individual countries directly, threatens most countries through contraction in global trade (estimated to be between 13 and 32% by the WTO in 2020), limited financial capabilities to address budget shortfalls and increased unemployment and challenges to existing health care infrastructure from the pandemic. Multilateral institutions like the World Bank and the IMF and others are critical here but are dependent on the cooperation of key members like the U.S., China, and others. While these organizations have been working effectively to date, the size of the challenge posed by the pandemic which is unprecedented will likely result in additional funding needs in the coming months or years which will require cooperation to meet.

Conclusion

The United States and China have very different economic and political systems. In the trade sphere, the United States has reached the conclusion that coexistence of such disparate systems doesn’t make sense under the World Trade Organization’s rules which are premised on market-based economic policies. The U.S. actions vis-a-vis China on trade have been an effort to achieve reciprocity with China, a situation not possible under the existing WTO rules. That the U.S. effort to obtain reciprocity in fact is proving contentious is hardly surprising and will not likely lessen in bilateral tensions in the near future.

In the political sphere, our two systems have resulted and will continue to result in periodic tensions, such as we are currently witnessing over the actions of China on security measures in Hong Kong.

Historically, major nations who view each other as adversaries have been able to cooperate effectively on issues of mutual interest. That was true during the cold war between the U.S. and the Soviet Union on certain issues. Whether the U.S. and China view each other as adversaries as well as competitors at the present time, the same ability to cooperate between them should be true when looking at issues such as addressing the pandemic effectively and efficiently.

Let us hope that regardless of the bilateral tensions and of the U.S. departure from the WHO, all WTO Members can step up their efforts to keep markets open and transparent and that governments will cooperate to ensure that medical developments are available to all on an equitable and affordable basis and that the financial resources are available to help those least able to weather the pandemic’s effects alone to survive and move forward.

Continued Stress in U.S.-China relations — Reduced Cooperation in Multilateral Fora

The two largest economies in the world view each other as competitors and potential adversaries. With significantly different political and economic systems and ideologies, the United States and China have had different perspectives on commitments and obligations undertaken in the economic sphere.

U.S. concerns

Specifically, the United States has viewed its bilateral trade negotiations with China and the later conclusion of China’s accession to the World Trade Organization (“WTO”) as having created a commitment by China to continue on market-based reforms with the eventual conversion of the Chinese economy into a market-economy consistent with the basic rules of the WTO. There have been high level dialogues between the two countries for years with a feeling in the U.S. that repeated commitments by China to fulfill commitments have not been honored and that the bilateral relationship had growing serious problems.

China concerns

China has had a different view of the world and its obligations to other countries through its joining the WTO. Reforms continued for a while but were replaced with a growing focus on state direction, state investment and heavy subsidization of a widespread number of sectors. China has viewed the United States as attempting to prevent its economic growth and global role and as not respecting its “right” to view itself as a developing country within the WTO and hence to have fewer obligations than a developed country.

Trump Administration changes approach

Under the Trump Administration, the United States has taken a more aggressive approach to dealing with what it perceives as distortions in economic competition and lack of meaningful reciprocity in the bilateral trade relationship. The U.S. has also looked at bilateral and multilateral approaches to address the problems it perceives China has created and is creating with the functioning of the global trading system.

Bilaterally, the U.S. has conducted its 301 investigation on a host of longstanding concerns of the U.S. business community on Chinese policies and practices. The adverse findings from the USTR investigation has led to the U.S. imposing additional tariffs on Chinese goods when resolution of the underlying issues was not achieved followed by retaliation by China and a series of additional rounds of more tariffs and more retaliation. The U.S. and China did engage in negotiations to see if they could resolve the underlying concerns of the United States. A phase 1 agreement was signed in January 2020, with a phase 2 process supposed to have commenced by May.

At the same time, the United States has pursued reform at the WTO (1) to address longstanding and bipartisan concerns with the WTO dispute settlement system, (2) to address rule changes to address some of the distortions that flow from China’s nonmarket economy, (3) to modify the self-selection nature of which Members are “developing” and (4) to improve transparency.

On transparency, many countries are not current on the various notification requirements, but major concerns have existed with China and India in terms of the number and dollar value of subsidy programs that are not being reported in their notifications to the WTO.

Some of the reforms of interest to the United States are being pursued as well by others, such as the EU and Japan on state-invested companies and industrial subsidies and various other countries on transparency.

But the WTO has been struggling to achieve forward movement on many issues of importance to different Members in part due to lack of consensus on issues and a lack of leadership/coordination among major players.

COVID-19 Complicates the Bilateral Relationship

The COVID-19 pandemic has complicated the situation for the WTO and for U.S.-China relations both because of the global reach of the health problem resulting in reduced functionality of the Missions in Geneva and the current inability to hold face-to-face meetings and the widespread use of export restraints on medical goods (including personal protection equipment like masks, gloves, shields, gowns, etc.) as demand in nations with significant number of infections has grossly exceeded existing inventories and production capabilities both in country and globally.

In terms of U.S.-China relations, the lack of complete transparency by the Chinese in the early months of the COVID-19 outbreak, some slowness of action by the World Health Organization, and both missteps on testing and slowness of initial action within the United States (and resulting massive unemployment, costs to the economy and multiple trillion dollar government response) has added finger pointing on the pandemic to the already tense bilateral relations. It has also resulted in the U.S. distrusting the WHO and temporarily suspending U.S. funding for the organization.

With the collapse in global trade, the pandemic has also made it far less likely that China will honor its increased import commitments from the U.S. in 2020 as contained in the Phase 1 Agreement. See U.S.-China Phase I Agreement – some progress on structural changes; far behind on trade in goods and services, https://currentthoughtsontrade.com/2020/05/12/u-s-china-phase-i-agreement-some-progress-on-structural-changes-far-behind-on-trade-in-goods-and-services/. That said, the U.S. continues to identify important advances being made at least in agriculture with China. See https://ustr.gov/about-us/policy-offices/press-office/press-releases/2020/may/usda-and-ustr-announce-continued-progress-implementation-us-china-phase-one-agreement.

On trade, the pandemic has crippled the economies of many countries with the resulting declines in imports and exports in the March-April time frame and likely going forward for some period, though China as the first country through the outbreak and a major producer of medical goods actually saw increased overall exports to the world in April.

United States Strategic Approach to The People’s Republic of China

Earlier this week, the White House forwarded to Congress a document required by the 2019 National Defense Authorization Act, United States Strategic Approach to The People’s Republic of China. On the trade/economic front, the paper repeats the concerns that the Administration has laid out in other documents most of which are summarized above (not including the COVID-19 issues). The U.S. views challenges from China to three broad areas — (1) economic challenges (largely failure to continue reforms to become a market economy, failure to honor commitments made to the US, use of predatory practices, insistence on being a developing country, etc.); (2) challenges to U.S. values; and (3) security challenges. The link to the document is here and the text is embedded below. https://www.whitehouse.gov/wp-content/uploads/2020/05/U.S.-Strategic-Approach-to-The-Peoples-Republic-of-China-Report-5.20.20.pdf.

U.S.-Strategic-Approach-to-The-Peoples-Republic-of-China-Report-5.20.20

Challenges for the WTO

The WTO remains able to move forward where issues are limited to a subset (the “willing”) as progress on e-commerce talks would support. But in a consensus based system, distrust between major players will paralyze large parts of any agenda. Indeed, with the large number of WTO Members (164) at various stages of economic development, there will almost always be a wide divergence of views on any issue. In such a situation, leadership and cooperation among major economies become important to develop a consensus. So it is hard to see how the WTO advances a reform agenda without improved relations between the organization’s two largest Members.

With the recently added challenge for the WTO of selecting a new Director-General, the sour relationship the U.S. and China will likely make finding a candidate who would be supported by a consensus of the Membership that much harder, suggesting at a minimum a process that takes the full six-month time for selection (versus any hoped for expeditious resolution in light of DG Azevedo’s departure at the end of August) and perhaps extended time lines. If the selection process breaks down into highly polarized camps (the existing procedures were developed to try to prevent such an outcome), the ability to move forward the WTO’s reform and existing negotiating agenda will be delayed by certainly months and perhaps longer.

Conclusion

At a time when the world is struggling with a global pandemic which continues to cause huge health challenges to many countries in the world and has devastated the global economy at least temporarily, costing tens of millions of workers jobs, and likely closing hundreds of thousand of businesses around the world while requiring government financial support that will likely exceed ten trillion dollars, there is an unfortunate lack of global cooperation between the major economic players and distrust at least from the U.S. of multilateral institutions viewed as either ineffective to deal with China’s economic system or not operating in an unbiased manner.

A major part of the challenge flows from the distrust that exists between the world’s two largest economies that precedes the pandemic but that has been worsened by the pandemic’s development and handling. The two countries have different economic systems which are essentially non-compatible, have different political systems and different ideologies and view each other as competitors and potential adversaries.

In a change of approach, the United States has decided to take a more aggressive approach to achieve reciprocity in fact with China and not merely on paper or from spoken promises. The change in approach has resulted in the U.S. acting unilaterally in certain situations. China has appeared unable to understand or agree with the concerns raised by the U.S. (and others) and harbors a belief that the real motive behind U.S. actions is “to keep China down”. This mutual distrust has resulted in both hard feelings and an inability to achieve cooperation on a large number of trade, economic and other issues.

The current U.S.-China relationship increases the problems for many multilateral organizations, but certainly for the WTO both in terms of selecting a new Director-General and in developing WTO reforms and moving ongoing negotiations forward.

Look for a challenging second half of 2020.