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China deal wouldn't change much

China deal wouldn't change much

May 11th, 2019 by Tyler Cowen in Opinion Columns

Right now many of us are suffering from a combination of whiplash and fatigue brought on by the Trump administration's trade talks with China. Are his tweets real threats, or a bluff, or just reflective of his mood? Is Vice Premier Liu He coming to Washington to resume the talks or not? How will markets react to each new development?

Yes, these machinations matter. But it is more important to focus on the big picture: The trade talks are chaotic because a trade deal would be chaotic. By which I mean, it would be difficult to interpret and enforce, not unlike the present situation. All this is true even without considering the additional uncertainty introduced by the unique personality and communication methods of Donald Trump.

The basic problem is easy enough to state, though it is all but impossible to solve. Many of the U.S. objections to Chinese trade practices, regardless of their merits, are fundamental objections to how the Chinese economy is organized. They are more than mere complaints about easily monitored variables such as tariff rates.

The Chinese economy is rife with state-owned enterprises, which receive cheap credit from state-owned or state-connected banks, as well as numerous other government privileges. Furthermore, China engages in extensive industrial espionage, which is not easy to trace or confirm, even when you know it is going on. The Chinese are also enacting a systematic industrial policy to catch up to or surpass the U.S. in some crucial areas, again with government aid. This complex environment cannot be well-summarized by facts or numbers.

In short, any attempt to rein in China faces the problem of how to enforce the discipline. China's transgressions, or supposed transgressions, are hard to confirm and monitor. Economists sometimes draw a distinction between observable categories and verifiable ones, and the enforcement of a well-functioning trade agreement relies on verifiability, not just a general feeling that the other partner is failing to cooperate. There simply isn't an easy way to "catch China red-handed," even if highly objectionable policies continue or accelerate.

What about well-established rules like those of the World Trade Organization? They are not much help, either. No matter what happens, there will still be debates about just how much China's policies are compatible with the letter or spirit of WTO rules. China's trade practices have been going on since well before China joined the WTO, and the WTO adjudication process won't settle matters. The more relevant point, now and in the future, is whether the Trump administration is unhappy.

The issue will still be enforceability in a situation with relatively few clear metrics. If a China trade agreement were in place, no matter what it said, it would still be hard for the U.S. to call out China for lack of compliance on many issues, much less prove the case.

On the other side of the agreement, what the Chinese want is relatively easy to identify and enforce: They would like to see some version of the status quo continue—which is to say, they do not want the U.S. to levy high tariffs on Chinese imports.

This asymmetric difficulty of enforcement helps explain at least two features of the bargaining. First, the Trump administration wants to keep at least some of the tariffs on Chinese products in place, even after an agreement is struck. That doesn't make economic sense—isn't the whole point of a trade agreement to lower tariffs?—but it is more understandable in view of the enforcement difficulties any deal would present. Having the right to keep some of its tariffs in place would allow the U.S. to keep some of its leverage.

Second, Trump has single-mindedly focused on reducing the U.S. trade deficit with China, even though economists insist on telling him that he is wrong. That is one of the few concrete demands the U.S. can make and actually enforce. The bilateral trade deficit is a measurable number, and setting a goal of reducing it gives China some incentives to reorganize their purchasing and order more U.S. goods. (Ironically, this very change would require China to increase state control over its economy, the opposite of America's larger objective.)

If a trade agreement is concluded, then, it is likely to have two parts: the parts that are easy to enforce, and the parts that aren't. To the extent that the U.S. insists on greater Chinese compliance on the easier parts, a self-interested China will respond by shifting more trade onto the difficult-to-enforce parts of the agreement.

The tug of war will never cease. Trump will continue to tweet and move markets. The Chinese will continue to organize their economy to maximize state control. And maybe, over time, we will all recognize the broader truth: In a highly legalistic world, vague and hard-to define-strategies offer a competitive advantage.

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