GLOBAL DIALOGUE
Volume 9 ● Number 1–2 ● Winter/Spring 2007—The Rise of China Engagement or Protectionism? US Policy towards China
So why do some in Congress see China as an inevitable enemy and trade as a zero-sum game? Is China’s economic rise necessarily a threat to US economic and national security? Would economic nationalism and protectionism serve US long-term interests or deny China the very economic freedom the United States prizes? The central argument in this article is that US economic security, as well as China’s, will depend on promoting economic liberalism rather than reverting to destructive protectionism.
US and Chinese economic and national security will ultimately depend on a liberal international economic order. Free trade may not suffice to prevent conflict, but the existence of a global network in which people co-operate in private markets clearly facilitates economic and social harmony. Upsetting that harmony by reverting to protectionist measures would isolate nations and embolden hardliners. The wealth of nations would suffer and the risk of conflict would increase. To minimise that risk, Henry Paulson, secretary of the US Treasury, has initiated a “strategic economic dialogue” with China. In his words, “Protectionist policies do not work, and the collateral damage from these policies is high.”1
The case, as Secretary Paulson puts it, for “long-term strategic economic engagement” is that trade liberalisation is mutually beneficial and that a growing middle class in China will create a demand for greater personal and political freedom. Those in the United States who may be harmed by international competition, and who have been protected in the past by government favours in the form of tariffs, import quotas, and other protectionist measures, will often use the national security card to trump freer trade—even when there is no genuine security threat. That was surely the case when Congress intervened to thwart the Chinese National Offshore Oil Company’s bid for Unocal.
The new Speaker of the House of Representatives, Nancy Pelosi, is a long-standing “trade sceptic” who voted against permanent normal trade relations with China. She is impatient with the pace of change in China and especially with the argument that economic reform will lead to political reform. In her view, and in the view of the Democratic Party majority in Congress, the United States needs to take stronger steps to gain access to Chinese markets and to advance human rights.
Those are desirable goals, but they are unlikely to be achieved by protectionist pressure from Washington. Placing prohibitively high tariffs on Chinese goods, as Senator Charles Schumer, a New York Democrat, and Senator Lindsey Graham, a South Carolina Republican, recommended in the 109th Congress (January 2005–December 2006), would penalise US consumers, slow US exports to China, increase US interest rates, fail to balance the US trade deficit, and increase the risk of a trade war—thus increasing the likelihood of future conflict. Although the senators have dropped their call for a 27.5 per cent tariff on all Chinese imports unless China revalues its currency by that amount against the US dollar, new measures will be introduced in the current, 110th Congress (January 2007–January 2009) to ensure “fair” trade.
There are legitimate reasons for taking measures against China if it does not honour its WTO commitments, but those measures are best taken through the WTO dispute-resolution mechanism, not the US Congress.
The remainder of this article will examine the rise of economic liberalism in China, the threat of economic nationalism, the promise of the strategic economic dialogue, and the case for a liberal global economic order—or what President Hu Jintao of China has called “peaceful development”. China Embraces the MarketNo country has done more to reduce global poverty than China. Real per capita income has increased more than five-fold since its economic reforms began in 1978. China’s transformation from a centrally planned economy modelled on the former Soviet Union into a vibrant market-oriented system in which most prices are freely determined by supply and demand has been a step-by-step process. The central government has allowed experimentation and the evolution of new institutions, including a variety of ownership forms. As a result, the non-state sector has grown dramatically, especially in the area of foreign trade.
In 1978, only twelve large state-owned enterprises (SOEs) had the right to engage in foreign trade. Today, virtually any firm is free to enter the import–export business. China has become the world’s third-largest trading nation and is the leading destination for foreign direct investment. Those regions that have experienced the greatest amount of economic freedom have also grown the most and have the highest living standards. The provinces of Guangdong, Zhejiang, and Fujian are all heavily “marketised”—SOEs account for only a small fraction of output—and have growth rates far above the national average.
Fan Gang and his colleagues at the National Economic Research Institute in Beijing have devised a “marketisation index” to reflect how close provinces are to an idealised market economy. Some of the factors considered are size of government, ownership structure, trade restrictions, price controls, development of factor markets, and the legal framework.
Coastal areas score especially well compared to the central and western regions. They do so not because of geography but because they began to liberalise much sooner than other areas. Provinces in the top fifth of the marketisation index have a much higher average per capita income than provinces with less economic freedom.
Although China’s overall economic freedom score is relatively low, it has been rising. According to the Fraser Institute’s “chain-linked” economic freedom index, in 1980 China achieved a score of only 3.8 out of 10, but by 2004 that score had increased to 5.7.2 Hong Kong, meanwhile, has retained its world number-one ranking for economic freedom, and no doubt has influenced Beijing in its transition from plan to market.
China’s opening to the outside world since 1978 has linked domestic prices to the international price system, increased competition by expanding the private sector, and widened the range of individual choice. People can own their own homes and businesses, work outside the state sector, shop in Hong Kong or travel abroad, exchange information over the Internet or on cell phones, and learn about the free market. One social observer writes, “The old control system has weakened in many areas, especially in the spheres of economy and lifestyle. There is a growing sense of increased space for personal freedom.”3
Of course, many illiberal economic policies persist, human rights are not protected by a transparent rule of law or by an impartial justice system, and the Communist Party retains a monopoly on power. Those failures, however, should not blind the West to the significant progress China has made since abandoning rigid central planning in favour of a “socialist market economy”. Deng Xiaoping and those following him have chosen a path of “peaceful development”, with the aim of reducing poverty and allowing greater scope for individual decision-making as opposed to state planning.
Although more than 90 per cent of China’s prices are now market determined, the legacy of central planning is still evident in the country’s repressed financial sector: interest rates are heavily regulated, capital controls limit investment opportunities, the exchange rate is not free to move with market demand and supply, state-owned banks funnel capital to SOEs, and few private firms are allowed to list on the domestic stock exchanges. Financial liberalisation is occurring, but at a slow pace.
The Communist Party faces a dilemma: if it wants to retain power it must continue to marketise the economy to spur development; but, as the private sector grows, people will demand greater autonomy. In a 2005 poll covering twenty countries, GlobeScan found that China had the highest proportion of respondents (74 per cent) who agreed that the “free market economy is the best system on which to base the future of the world”. That outcome is remarkable given that only a short time ago Beijing embraced a state-led development model.
The same poll found that US citizens strongly support the free market (71 per cent) while Russia, which has a long anti-capitalist history, still evinces rather weak support (43 per cent favoured the market), and France, with its enduring attachment to socialism, shows even less support, with only 36 per cent saying they favour a free market.
A second survey confirms the significant change in Chinese attitudes towards capitalism in recent decades. The Chicago Council on Global Affairs, in a 2006 multi-nation survey of public opinion, found that 87 per cent of those polled in China thought “globalisation, especially the increasing connections of their country’s economy with others around the world, is mostly good for their country”. That result compares with 60 per cent in the United States and 54 per cent in India.
It is not surprising that the Chinese people should embrace globalisation, as it has broadened their horizons and improved millions of lives. In widening the range of opportunities open to people, globalisation has put pressure on the Communist Party to allow even more economic liberalisation—with a positive impact on civil society.
Under the old system of central planning and autarky, people were not free to choose: they worked for the state and were wards of the state. Today, one can shop in a modern supermarket, own a car, and read a leading business magazine like Caijing that displays a glossy photo of the Statue of Liberty on the same page as an advertisement for private condominiums. High school students in Shanghai can now open their new history textbooks and find much discussion of globalisation and economic reform, but only a single reference to Mao. Most surprisingly, one can travel to Chengdu’s Southwestern University of Finance and Economics and see a statue of Adam Smith, the great Scottish liberal and intellectual founding father of free-trade capitalism.
Trade liberalisation has been good for China and good for the global economy. Even though millions of Chinese workers have been dislocated, the Chicago Council survey found that 65 per cent of those polled in China believe that “international trade is good for the job security of workers”. In contrast, only 30 per cent of Americans surveyed thought foreign trade benefited US workers.
The goal of trade, of course, is not to protect jobs but to create wealth—and global wealth is much greater today than it was two or three decades ago. Trade liberalisation, the information revolution, and financial integration have combined with pro-market institutional change to make China’s future—and that of the global economy—bright.
Although China has made substantial progress on its march towards the market, much remains to be done. Free markets require widespread private property rights, a transparent and just legal system, and the free flow of information. Moreover, if China is to develop world-class capital markets, Beijing must make its currency, the renminbi (also known as the yuan), fully convertible and allow capital freedom.
Opening the Communist Party to capitalists is not sufficient. The party’s monopoly on power has to be contested at some point. Nor is it sufficient to amend the Chinese constitution to provide better protection for private property when there is no independent judiciary to enforce contracts. In March 2007, the National People’s Congress, China’s parliament, passed a new property law to strengthen private property rights. That is good news, but the law failed to provide farmers with permanent and transferable land-use rights. Without such rights, corruption and injustices will continue. More important, the law will have no teeth unless there is also meaningful judicial reform, which appears unlikely in a one-party state.
If China’s future is to rest with the free market, there must be political as well as economic liberalisation. Ultimately, a free market cannot exist without a free people. The real challenge for Beijing will be to institute a rule of law that protects persons and property against the state. The impetus for that change, however, must come from the people; it cannot be imposed on China from the outside. Indeed, threatening China with trade sanctions unless it adheres to Washington’s agenda will reduce freedom and foster crude nationalism. US Economic NationalismThe rise of China as a global economic power has made it the target of acrimonious attacks on Capitol Hill. As the US trade deficit with China reaches new highs ($232.6 billion in 2006), there is growing pressure on Congress and the White House to do something. Legitimate concerns over violations of intellectual property rights and the lack of access to China’s financial markets, however, should be distinguished from a narrow focus on the exchange rate or the use of anti-dumping laws to penalise China (and US consumers) when a real comparative cost advantage exists.
The logic of US economic nationalism is simple: manufacturing is essential for national security; China is unfairly crowding out US manufacturing jobs; therefore, China is a threat to America’s security and must be sanctioned. Instead of blaming the trade deficit with China on low US saving and persistent budget deficits, it is far easier to blame China’s undervalued exchange rate, export subsidies, and restrictions on market access. But why worry about the bilateral trade deficit at all? It simply reflects the myriad of consensual exchanges that create wealth for the parties involved. Viewing trade as a zero-sum game in which one party wins and the other loses is to misunderstand the very nature of market-based exchange.
The trade deficit has become a red herring to divert attention from the size and scope of the US government, which relies on coercion—not consent—to acquire its resources. Unlike the trade deficit, the budget deficit reflects the power of government. (Government securities could be sold on the open market to finance a deficit, but at some point those promises have to be honoured by raising taxes.)
Threatening to use the force of the US government to bring China’s exchange rate in line with what some politician or economist thinks is the “right” price is the height of hubris. China needs time to allow the institutions of a market-based capital market to develop and to alter its exchange-rate regime. Since July 2005 when China ended the rigid peg of 8.28 renminbi to the dollar, the renminbi has appreciated by about 6 per cent and is expected to appreciate by another 4–5 per cent this year. China is developing futures markets for hedging and has begun to open its capital markets. People and businesses will increasingly be able to keep more foreign exchange and to invest abroad, thereby taking some pressure off the renminbi/dollar rate. The People’s Bank of China will then be freer to focus on domestic price stability and let markets determine the foreign exchange value of the renminbi. Congress should welcome those steps towards capital freedom.
Much of that progress, however, has been ignored, with critics focusing on China’s growing demand for energy resources, its deals with rogue states, its violation of human rights, its undervalued currency, and so on. In his opening statement on 14 February 2025 before the House Subcommittee on Oversight and Investigations (a subcommittee of the International Relations Committee), Representative Dana Rohrabacher, the chairman, referred to China’s “unchallenged displays of arrogance and power”. Accusing the Chinese government of aiming to establish China “as a powerful force anywhere in the world”, he averred that, “as with past evils, the United States is the only force able to thwart their megalomaniacal goals.” He concluded: “It’s time to cut the obfuscation and face the facts concerning the greatest long-term threat [to] the United States and to the stability of the world.”
The hyperbole connected to the threat of a rising China is not uncommon. In its 2005 Report to Congress, the US–China Economic and Security Review Commission (also known as the US–China Commission) argued: “The trends in the U.S.–China relationship have negative implications for our long-term national economic and security interests … China is an authoritarian regime and has a non-market, command economy still controlled by the Communist Party.”4
The commission, no doubt, would be surprised to learn that GlobeScan found more support for the free market in China than in the United States, Europe, or India, and that the title of the most recent five-year “plan” has been changed to “programme”. Two of the main goals of the eleventh Five-Year Programme are to deepen economic reforms, including further trade liberalisation, and to build a “harmonious society”. Although China has not yet grasped the “big market, small government” model of Hong Kong, it is clearly not the “non-market, command economy” assumed by the US–China Commission.
In its 2005 Report, the US–China Commission recommends to Congress the imposition of “an immediate, across-the-board tariff on Chinese imports at the level determined necessary to gain prompt action by China to strengthen significantly the value of the RMB [renminbi]” (p. 70). It asserts that “China’s undervalued currency has contributed to a loss of U.S. manufacturing, which is a national security concern for the United States” (ibid.). The truth is that net job losses in US manufacturing since 2000 have been due primarily to the sharp increase in US productivity, not to Chinese imports or an undervalued renminbi. US trade expert Daniel Griswold estimates that annual job losses in the United States caused by imports from China “account for only about 1 percent of overall job displacement”.5 Imposing a prohibitive tariff on imports from China in order to force an appreciation of the renminbi would be counterproductive. It would severely damage US–China relations and escalate defence spending in both countries.
There are legitimate concerns about China, but it is best to look at its concrete actions rather than try to divine intentions. Indeed, it is dishonest to use the guise of national security to protect US interest groups which have benefited from government intervention.
In his dissenting opinion on the 2005 Report, Commissioner William Reinsch criticised the majority’s view for its “negative tone”. Instead of seeing the opportunity for long-term engagement, the majority paints China as an emerging threat:
The Report’s perspective is simple and simplistic: we are right; China is wrong; the only issue is how to force them to do what we want. The recommendations are equally simplistic—we should tell them what we want them to do and then sanction them if they don’t do it. The Report consistently implies the Chinese deserve blame for acting in their own interest rather than ours … Despite overwhelming evidence that unilateral sanctions fail to achieve their objectives and at the same time impose significant costs on the sanctioning nation, the Commission continues to recommend their imposition or expansion.6
The danger is that the current Democratic-controlled Congress might actually take the US–China Commission’s advice. House leaders are demanding that US trade law be amended to allow countervailing duties to be imposed on China for “unfair subsidies”, including implicit subsidies due to “currency manipulation”—even though such duties are normally not used against non-market economies. In the Senate, there are voices calling for an end to normal trade relations with China. Although such an act would violate WTO rules and is highly unlikely, the combative tone of the bipartisan group urging the move is the wrong message to send China at a time when the Bush administration is entering into its strategic economic dialogue intended to smooth long-term relations with Beijing. Strategic Economic DialogueInternal politics will largely determine the pace of reform in China. Beijing will not kowtow to foreigners but will listen. The United States is China’s largest single trading partner and does have leverage, but that leverage should be used judiciously. Strategic long-term economic engagement is a sensible policy designed to make China a “responsible stakeholder”—that is, to help sustain the liberal international economic order. If China honours its commitments to the WTO and adopts international norms in conducting its trade policy, there will be a win-win situation. Both the United States and China will gain, as will the global economy.
However, one should not forget that China unilaterally reduced its trade barriers before it joined the WTO and reaped considerable gains. Negotiated trade deals are often politicised and impair free trade. The United States can best help China by adhering to the free-trade principles that it preaches and by cutting the size of government. Global imbalances can be smoothed out if market forces prevail and if the United States gets its fiscal house in order. China can help by allowing greater flexibility of its exchange rate, by redirecting some of its vast foreign-exchange reserves towards productive domestic investment, by relaxing capital controls, and by adhering to the rule of law.
Treasury Secretary Paulson is correct to urge institutional change in China rather than narrowly focus on the renminbi/dollar rate. China has promised to open further its financial sector and should be held to that commitment. The US Treasury has not yet labelled China a “currency manipulator”, but there is increasing pressure to do so. Paulson should resist that pressure and continue to point out to China the benefits of letting the renminbi eventually float and of removing capital controls. He should also stress the importance of widespread private ownership of capital assets and the free flow of information if China is to become a world-class financial centre.
If Washington wants access to China’s capital markets, Beijing must be assured that Chinese investors have access to US markets, including the right to acquire energy assets. The secretive Committee on Foreign Investment in the United States, headed by the secretary of the Treasury, should be diligent but not interfere with foreign acquisitions that pose no legitimate security risk. China should be treated as a normal rising power rather than an adversary, unless its actions prove otherwise.
Secretary Paulson recognises that “closer economic ties between nations help promote international peace and prosperity by creating common interests and raising the costs of conflict”. He therefore cautions both the United States and China to avoid being “captured by harmful political rhetoric or those who engage in demagoguery”. Instead, we should realise that constructive Sino-American relations require “a long-term strategic economic engagement on our common issues of interest”.7
Strategic economic dialogue together with prudent use of the WTO dispute-resolution mechanism to address US–China trade issues is superior to attempts by an activist Congress to win votes regardless of long-term consequences. As then–US Federal Reserve chairman Alan Greenspan warned, “[if] the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalization, the adjustment process could be quite painful for the world economy.”8 The Case for Economic LiberalismFrom a liberal perspective, economic development means an increase in “the range of effective alternatives open to people”, as the late economist Lord Bauer was fond of reminding his contemporaries who advocated state-led development.9 Restricting trade and capital flows reduces personal freedom, politicises economic life, and reduces wealth creation. Although Hong Kong has few natural resources, its institutions and adherence to the rules of a liberal market order have provided a framework for peace and prosperity. China will be less of a threat if it follows Hong Kong’s development model and continues to integrate itself into the global marketplace.
US economic security, as well as China’s, depends on promoting economic liberalism, rather than on fostering protectionism. Any missteps that weaken the liberal global economic order and fuel economic nationalism will undermine a constructive US–China policy of engagement.
We must not repeat the mistakes of the 1930s, when the Smoot–Hawley tariff and monetary-policy errors in effect ended the liberal international order. Free trade and financial integration are essential for prosperity and peace. As Cordell Hull, US secretary of state from 1933 to 1944, wrote, “Unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition with war.”10
Beijing can help resolve global imbalances by moving towards a more flexible exchange-rate regime and liberalising capital outflows so that there will be less pressure on the People’s Bank of China to accumulate foreign reserves. Delaying adjustment means faster accumulation of reserves, greater risk of capital losses by holding dollar assets, and a stronger incentive to diversify. Delay also means an increasing threat of inflation as China’s central bank creates new renminbi to buy dollars. It is thus in China’s interest, as well as that of the United States, to move forward on the issue of capital freedom.
Viewing China as a threat equivalent to or greater than that posed by the Soviet Union is misleading and dangerous. It is misleading because, unlike the former Soviet state, China is not autarkic, is no longer a command economy, allows capitalists to join the Communist Party, recognises the importance of the private sector, and is not committed to dominating the world or to “burying” the United States. China is dependent on the global economy—especially the rich nations of the West, but also Taiwan, Hong Kong, and other Asian countries—to sustain economic growth. That interdependency is an important deterrent to conflict. As Robert Zoellick, then–US deputy secretary of state, noted in his remarks to the National Committee on US–China Relations in September 2005, “China does not believe that its future depends on overturning the fundamental order of the international system. In fact, quite the reverse: Chinese leaders have decided that their success depends on being networked with the modern world.”
Likewise, viewing China as an inevitable threat is dangerous because it could lead to serious policy errors, such as protectionist measures based on bogus security arguments or on a zero-sum/mercantilist mentality. That mentality is evident today on Capitol Hill. Representative Barney Frank, chairman of the powerful House Financial Services Committee, when asked “how best to deal with China’s undervalued currency”, responded: “We threaten economic retaliation … I’d tell the Chinese we’re going to put some restrictions on what they can sell here. If they couldn’t sell in America, they would fall apart.”11
Restricting what China can sell restricts what US consumers can buy. Economic freedom is lost on both sides. Do we really want China to “fall apart”? Is that the message Chinese liberals want hardliners to hear in Beijing?
Instead of threatening China, America should continue to engage it and to promote long-term institutional change there. The “inevitable clash” will then not be between the United States and China, but between the Communist Party and the private market system—that is, between power and freedom. The more the market advances, the greater will be the range of individual choice and the stronger will be the pressure to protect the private sphere by limiting the power of government and the Communist Party.
President Hu Jintao’s goal of building a “harmonious society” is noteworthy and was given substance when the sixth plenum of the sixteenth Communist Party Central Committee approved the “Resolutions on Major Issues Regarding the Building of a Harmonious Socialist Society” in October 2006. But one cannot create harmony from the top down. Social and economic harmony depend on freedom and thus on the protection of private property rights and the rule of law. The Central Committee’s communiqué does pay lip service to human rights and the rule of law, but the present judicial system is far from enforcing those values.
What China needs is the spontaneous order of Adam Smith and Lao Tzu. Many centuries before Smith wrote his Wealth of Nations (1776), Lao Tzu argued that when the ruler takes “no action”, “the people of themselves become prosperous”. The principle of non-intervention (Lao Tzu’s wu wei) should be the key to China’s future, as well as US policy. In particular, US policymakers should:
● Treat China as a normal rising power, not as a probable adversary.
● Recognise the dangers of protectionism and the positive contributions economic freedom and engagement have made towards advancing personal freedom in China.
● Extend market status to China as soon as possible to end the arbitrary and unfair anti-dumping methodology currently used under China’s “non-market” classification.
● Hold China to its WTO commitments and encourage further liberalisation through the strategic economic dialogue.
● Practise what they preach in terms of adhering to the rule of law, limited government, and the principle of freedom.
By following the Tao of the market, China and the United States are more likely to achieve the peace and prosperity that all people desire. China’s future lies in “peaceful development” not in conflict. But as Liu Junning, director of the Cathay Institute in Beijing, points out: “Whether China will be a constructive partner or an emerging threat will depend, to a very great extent, on the fate of liberalism in China: a liberal China will be a constructive partner; a nationalistic and authoritarian China will be an emerging threat.”12 The challenge is to nudge China in the right direction, not by the threat of destructive protectionism but by the promise of freedom.
2. James Gwartney and Robert Lawson, Economic Freedom of the World: 2006 Annual Report (Vancouver: Fraser Institute, 2006), p. 19. There is a two-year lag in reporting the Economic Freedom of the World Index.
3. Jianying Zha, China Pop (New York: New Press, 1995), p. 202.
4. US–China Commission, 2005 Report to Congress, 109th Congress, 1st session, November 2005 (Washington, D.C.: Government Printing Office, 2005), p. 19.
5. Daniel Griswold, “Who’s Manipulating Whom? China’s Currency and the US Economy”, Trade Briefing Paper no. 23, Cato Institute, Washington, D.C., 11 July 2006, p. 8.
6. US–China Commission, 2005 Report, p. 218.
7. “Treasury Secretary Remarks on International Economy”, Washington Post, 13 September 2006.
8. Greg Ip, “Greenspan Softens on Trade Deficit”, Wall Street Journal, 3 December 2005.
9. See James A. Dorn, “Economic Development and Freedom: The Legacy of Peter Bauer”, Cato Journal 20, no. 2 (autumn 2002), pp. 355–71.
10. Cordell Hull, The Memoirs of Cordell Hull, vol. 1 (New York: Macmillan, 1948), p. 81.
11. Barney Frank, “Barney Frank’s ‘Grand Bargain’ ”, interview by Lorraine Woellert, Business Week Online, 8 January 2007.
12. Liu Junning, “The Intellectual Turn: The Emergence of Liberalism in Contemporary China”, in China’s Future: Constructive Partner or Emerging Threat?, ed. Ted Galen Carpenter and James A. Dorn (Washington, D.C.: Cato Institute, 2000), p. 60. |