The Rule of Law: China and the U.S.

The rule of law has been an essential and critical foundation of successful free market economies. It provides the certainty of property rights and contracts needed for entrepreneurs to risk their capital in business undertakings. But as our business and other activities cross borders, whose laws apply?

“Among the earliest examples of legal codes concerning maritime affairs is the Byzantine Lex Rhodia, promulgated between 600 and 800 C.E. to govern trade and navigation in the Mediterranean.” https://en.wikipedia.org/wiki/Law_of_the_sea  Leaping forward, international air travel, satellite communications, spectrum allocation for radio, TV, internet, and other telephonic transmission would be impossible without firm agreements among countries–the international rule of law.

Laws facilitate commerce–buying and selling–by establishing rules for doing so (e.g. contract enforcement rules) that are stable and applicable to all. They lower the costs and reduce the risks of trading. The United States Constitution recognizes the importance of this in the commerce clause of Article I Section 8, which is used to prevent individual states from taxing or otherwise interfering with interstate commerce. Achieving the same law-based freedom to trade across national borders is more difficult, requiring the negotiation of agreements and treaties that establish common rules between sovereign nations.

The World Trade Organization (WTO) develops and enforces the rule of law in the area of cross border trade. The difficulty of achieving global agreement on the rules of various aspects of trade is reflected in the fact that no new agreements have been reached since the establishment of the WTO (taking over the General Agreement of Trade and Tariffs) on January 1, 1995. “The WTO agreements cover goods, services and intellectual property. They spell out the principles of liberalization, and the permitted exceptions. They include individual countries’ commitments to lower customs tariffs and other trade barriers, and to open and keep open services markets. They set procedures for settling disputes.” the WTO – what is it?

China was admitted to the WTO as a developing country on December 11, 2001. Chinese officials immediately expressed the desire to understand and conform to the international rules required by the WTO and requested technical assistant from the IMF for doing so. In July of 2002, the IMF sent me to Beijing to review their needs with them.  They were particularly keen to have an American banking supervisor to advise them. I had a perfect candidate who was just finishing a two-year posting to Hong Kong. Everyone I spoke to in Beijing, as well as my Chinese colleagues at the IMF, stated that virtually all Chinese officials agreed on where China wanted to go–full liberalization according to WTO rules. They only differed with regard to how fast they thought they should move to get there.

Our condition was that our resident banking supervision advisor had to have his office located with the other Chinese banking supervisors and that he would have an open door. This was enthusiastically accepted by the Deputy Governor who apparently had not informed the Governor of these details. Unfortunately, when the Governor was presented the contract of his signature, he killed the arrangement. I was, however, able to enjoy wonderful tours of the Great Wall, the Forbidden City, and dine on the best Peking Duck I have ever had.  

An economically rising China is lifting millions of people out of poverty. We rightly welcome its newly productive economy contributing to increasing world output and living standards. The challenge is to square China’s authoritarian political regime with an international free market trading system. The vehicle has been the WTO and other international rule setting bodies that exist to harmonize diverse economies in the direction of freer and more open trade. The rules were being set by the dominant, largely free market economies that China wanted to join.

Beyond an American led WTO itself, the multilateral trade agreement that established the highest standards yet for tariff reduction and the incorporation of more modern trade issues such as non-trade barriers, services, protection of intellectual property, minimum labor standards, and dispute resolution (the rule of law cannot meaningfully exist without credible dispute resolution procedures) was the Trans-Pacific Partnership (TPP) negotiated between 2006 and 2015. The TPP agreement between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States was announced on October 5, 2015.

Three days later, on October 8, I spoke in New York City at a seminar hosted by the Chinese Chamber of Commerce of New York on the internationalization of China’s currency, the renminbi. All of the talk by the Chinese attending was about the TPP. Why was China excluded? Could they join? My reply was that China would be very welcomed to join when they were able to meet the treaty’s conditions. TPP was another powerful magnet pulling China into the liberal international trading order.  

A recent report from the Peterson Institute of International Economics (June 23, 2020) stated that: “The Trans-Pacific Partnership (TPP) was designed in 2016 to be almost China-proof, with stringent obligations requiring transparency and trade liberalization. As former US Trade Representative Michael Froman put it, Chinese participation would be welcomed only when China could meet TPP’s terms, which it was far from doing. The United States was not keeping China out; China was just not ready to come in.” “China and Trans Pacific Partnership-in or out”

Broadly speaking, the aim of the WTO is to increasingly move its member countries toward the freest trade possible with fair competition (a level playing field), thus promoting a more productive allocation of economic resources and lifting global incomes.  The organization is not without its problems. But rather than working to strengthen the WTO, President Trump turned to negotiating bilateral trade agreements and raising rather than lowering import tariffs. Clearly bilateral agreements are easier to conclude than are global or broad multilateral agreements. Trump focused on China and its large bilateral trade surplus with the U.S. out of the mistaken belief that its surplus (our deficit) was harmful to the U.S. and that reducing it would increase American jobs. “Who pays Uncle Sam’s deficits”

In one of his most short-sighted actions from a sadly long list, President Trump withdrew the U.S. from the TPP on January 23, 2017. In addition to tweaking a few existing trade agreements, such as the North American Free Trade Agreement (NAFTA) by incorporated many of the newer provisions of the TPP and the United States-Japan Trade Agreement and the United States-Japan Digital Trade Agreement, and imposing protective tariffs on solar panels, washing machines, steel and aluminum imports in the name of national security and “America First,” the Trump administration has focused its trade war bilaterally on China (with occasional pot shots at our friends in Europe and elsewhere).  “Trade Office fact-sheets and-annual-report”   A Brookings Institution study assessed the result of all of this for the American economy and workers as follows: “American firms and consumers paid the vast majority of the cost of Trump’s tariffs. While tariffs benefited some workers in import-competing industries, they hurt workers in sectors that rely on imported inputs and those in exporting industries facing retaliation from trade partners. Trump’s tariffs did not help the U.S. negotiate better trade agreements or significantly improve national security.”  “Did-Trump’s-tariffs-benefit-American-workers-and-national-security”

The remaining eleven countries that had signed the TPP agreed in January 2018 on a revised treaty they renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership” (CPTPP).  CPTPP is substantially the same as TPP, but omits 20 provisions that had been of particular interest to the U.S. These provisions can be relatively easily restored should the U.S. choose to rejoin. “Trade and Globalization”

With the increasing power of Xi Jinping, China’s President and the General Secretary/Chairman of the Central Committee of the Chinese Communist Party (now for life), China has played an increasingly active role in the IMF, WB, WTO and other international bodies. In addition, it has launched several regional organizations that it leads (the Asian Infrastructure Investment Bank, the New Development Bank–BRICS, and the Belt and Road Initiative) “The Asian Infrastructure Investment Bank and the SDR”  Xi Jinping claimed that the AIIB would adhere to the highest international standards. But as President Trump and others have noted, there are a number of important areas in which China does not abide by the WTO rules. The policy question is what should be done about it.

The Cato Institution began a recent review of China’s trade practices as follows: “There is a growing bipartisan sentiment in Washington that Chinese trade practices are a problem, since these practices are unfair to American companies in a number of ways. But there is disagreement about the appropriate response. Can multilateral institutions be of use here? Or is unilateralism the only way?” Their conclusion is that the WTO and other multilateral institutions would be the most effective way of continuing to pull China into compliance with the international rule-based system. “Disciplining China’s trade practices at the WTO-how -WTO complaints can help”

President Trump has unilaterally gone the other way. He has blocked Huawei, the world’s leading seller of 5G technology and smartphones, from U.S. 5G mobile phone systems and urged our European allies to do the same because of Huawei’s links with the Chinese government. He is attempting to block the sales of U.S. and other non-Chinese manufacturers of the semiconductor chips used in Huawei and other Chinese products to China.  “A-brewing-US-China-tech-cold-war-rattles-the-semiconductor-industry”  He is trying to ban TikTok, WeChat and other popular Chinese products from U.S. markets and raising tariffs on an increasing number of Chinese products imported into the U.S. Some of these measures might be justified on national security grounds but some seem more protectionist of U.S. companies that are not otherwise competitive.

We are basically forcing China to build its own alternative rules and approach to trade. It is even offering its own global tracking system in place of the GPS system the U.S. has given the world and they seem well along in dividing the World Wide Web and other Internet protocols into two worlds. https://www.voanews.com/east-asia-pacific/voa-news-china/chinas-rival-gps-navigation-carries-big-risks

A November 20, 2020 article by William Pesek highlights what Trump’s misguided trade war with China is producing: “On his presidential watch, Donald Trump did manage to make one thing great: economic cooperation within North Asia.

So chaotic and pernicious was the outgoing US president’s pivot away from Asia that China, Japan and South Korea are dropping the hatchet and joining hands. The unlikely union was formalized on November 15 with the signing of the 15-nation Regional Comprehensive Economic Partnership, or RCEP, free trade agreement.”  “US sidelined as China Korea and Japan unite”  The RCEP is a lighter more limited trade agreement than was the TPP (now the CPTPP) but it is led by China rather than the U.S.  Rather than converging to WTO standards it creates an alternative. 

“President Xi Jinping’s Friday [Nov 20, 2020] announcement of China’s intent to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), a high-standard mega regional trade pact, has been seen as a bold move to reassure the world of the country’s continuing commitment to reform and opening-up.” “News analysis: an uphill task for China to negotiate CPTPP accession agreement”  While Xi Jinping’s strategy for China’s ascension is to take over the leadership in forging the rules for the international order more to the liking of his regime, China’s younger and upcoming managerial and entrepreneurial class, many of whom studied in the U.S. and Europe, have seen and liked the freer and more open capitalist societies. Their patriotism and commitment to a rising China is informed by the knowledge that freer and more open economies thrive more than centrally controlled ones.  We should not overlook their potential for returning China to a path of liberalization and integration with the liberal international order enjoyed by the rest of us.

Xi Jinping and his government’s goal is to retain power by delivering rapid economic growth, which allows and requires a vibrant private sector, while overseeing tight political control. One example is provided by its Social Credit System.  “China’s social credit system-mark of progress or threat to privacy?”  This requires a different set of rules for cross border trade than set out by the WTO. But many of China’s world traveling citizens see China’s successful rise in more closely embracing free market capitalism. We should incentivize the later view.

President Trump’s trade policies have damaged the world’s rule-based trading system and hurt the American economy while turning China in a different direction. President elect Biden has indicated his interest in rejoining the TPP. He should give it and the rebuilding of the WTO and other multilateral bodies high priority.

About wcoats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My most recent book is One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon.
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1 Response to The Rule of Law: China and the U.S.

  1. Jim Roumasset says:

    The rule of law provides a constitution of liberty and voluntary exchange. Jimmy Lai argues that this is the most important human right, one that has been abrogated in Hong Kong. The CCP must have a different definition, inasmuch furthering the rule of law was given as justification for Lai’s arrest. And the UN Human Rights Council has a different idea about human rights.

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