Navarro holding short end of policy stick after latest China talks

Likely too much was made last week of Treasury Secretary Steve Mnuchin’s “globalism” versus White House National Trade Council Director Peter Navarro’s “nationalism” to explain tensions within the Trump administration in the run up to the second round of trade talks with China that took place Friday and Saturday.

Now that the talks are done, the real question is whether the results and plans for further negotiations will prove effective.  

{mosads}Calling a time out on the U.S.-China “trade war” while negotiations continue makes sense to allow the U.S. and global economy to keep percolating and bring down the $375 billion annual deficit in goods trade that the U.S. runs with China.

But the crucial question is whether China will make systemic changes that promote durable, shared economic progress. Can the Trump team stop China’s intellectual property rights (IPR) and technology theft and reorient China away from its unfair — and unwise — “Made in China 2025” strategy to unilaterally dominate high-tech sectors that will drive global growth for decades to come?  

Headlines notwithstanding, Mnuchin and Navarro, along with Commerce Secretary Wilbur Ross, Trade Representative Robert Lighthizer and National Economic Council Director Lawrence Kudlow, no doubt agree that China has advantaged their own industries by substantial state subsidies to key “Chinese champions.”

They are well aware that China has forced technology transfers and joint ventures as a condition of Western countries doing business in China’s vast market. Together, with theft of others’ technology, this has hurt U.S. industries, cost U.S. jobs and threatened our country’s competitive edge.

They also understand that President Xi Jinping’s 2015 Made in China 2025 strategy codified and strengthened China’s industrial policy of unprecedented scope, pouring hundreds of billions of dollars into 10 strategic technology sectors, from robotics to artificial intelligence.

Xi’s strategy is the Chinese version of President Trump’s “America First” strategy, but with massive government resources, policies and regulations to back it up.

The Trump team, led by Mnuchin, went into last week’s talks knowing that this “China First” approach is directly at odds with the “fair and reciprocal trade” system that President Trump seeks.

The president’s team also recognizes that China is no longer a weak player in the global economy, whose industries and companies are unable to survive without being excepted from global trade rules and disciplines.

So, what happened in the U.S.-China talks, which led to the joint statement issued on Saturday and caused global markets to head sharply upward as it appeared a trade war had been averted.  

First, while the U.S. did not agree to ease restrictions on China’s giant phone company, ZTE, for violating U.S. sanctions, it might be part of a final bargain. Nor did the Trump administration agree to specific measures to allow China to invest in the United States with fewer, largely national security-driven restrictions, as China has hoped.  

Second, China did not agree to reduce the U.S. annual goods trade deficit by $200 billion, as President Trump called for, arguing that deficit targets do not make good economic sense.

But China did agree to “significantly increase purchases of United States goods and services,” couched in terms of meeting the needs of their own people, including “meaningful increases in United States agriculture and energy exports,” which will be elaborated in future discussions.

Third, both countries asserted that protecting intellectual property rights is of “paramount” importance and agreed to “strengthen cooperation,” with China agreeing to “advance” changes to its laws and regulations. Together they will work to “encourage two-way investment” and to “create a fair, level playing field for competition.”

These are critical if still cryptic commitments. They go to the heart of whether the Trump team can actually persuade China to open its markets, treat “outsiders” as partners in mutually-beneficial relationships and compete within the bounds of international trade and investment rules.

Fourth, both the U.S. and China agreed to put on hold for now hundreds of millions of dollars in higher tariffs that threatened to raise the cost of consumer goods and inputs essential to producers in both counties, and which negatively impact the global economy.

China has also halted its anti-dumping case against U.S. sorghum exports, from states that helped to elect President Trump, and for which China is by far their biggest customer.    

Peter Navarro appears to have been left holding the short end of the policy stick, while the Mnuchin, Kudlow, Lighthizer and Ross perspective is ascendant.

The Mnuchin camp fears that an all-out trade war would damage the highly-integrated global economy just as it is running strongly on all cylinders, and recognizes China’s importance to a successful U.S.-North Korea summit.

It is unrealistic to think that China will walk away from its Made in China 2025 strategy to try to catapult itself up the economic value-chain any more than the Trump administration will abandon its America First strategy.

But China must be convinced of a better way to do so, especially given the alternative of tighter U.S. investment restrictions, billions in new tariffs, broken supply chains and lost economic activity.

Any internal tensions should not obscure the need for the Trump administration to use this unique window of opportunity. Threats of big U.S. tariff increases got China’s attention; now the U.S. team must negotiate a more balanced long-term economic relationship.

This would also be in China’s interest — helping its economy mature and diversify sustainably, and providing its consumers and producers more and better choices of goods and services.

If China is willing to be transparent about its subsidies and other industrial support mechanisms, to work cooperatively to avoid large, damaging distortions, to demonstrably open its markets and act to protect IPR and technology, the U.S. may be able to lift some investment restrictions, avoid imposing massive tariff increases and work with China to reduce national security frictions.

Despite the criticism by many that the Trump team abandoned specific trade-deficit reduction targets, this may force a more serious discussion of China’s structural policy restrictions.

In recent decades, China has lifted over 300 million people out of poverty, dramatically invested in human and physical capital and become the world’s second-largest economy. It now needs to act as a more responsible global citizen, which could be both a boon to global growth and stability, as well as to China’s own prosperity.         

A trade and investment framework between the world’s two biggest economies that is focused on concrete, economically-efficient steps to integrate, innovate and grow both economies would promote global growth; encourage others to support open markets and the rules-based trading system and would be a true global win-win.

Time will tell if the framework agreement is only a short-term palliative to avoid a costly trade war or the first step to longer-lasting systemic change in China.