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US-China trade

Trade, people, and money: Understanding China’s unique capabilities

Published 25 October 2018 | 8 minute read

The Trump administration is forcefully pressing its case on a variety of Chinese trade practices that it views as unfair or discriminatory. Successive rounds of punitive tariffs have been implemented, with more potentially to come. These may or may not have their intended effect, and could lead to wider conflict.

Although there has been no shortage of criticism of the tariffs (both in the United States and beyond), even their staunchest critics have frequently acknowledged that many of the United States’ grievances are legitimate. In fact, the European Union, Japan, and other trade partners have voiced many of the same concerns for years. There is a growing sense that China is not “playing by the rules” and that its practices of state-led and subsidized economic development need to be addressed one way or the other.

With the benefit of 20-20 hindsight, it is now clear that the impact of China’s 2001 entry into the global trade system via the World Trade Organization was profoundly underestimated. And the assumptions made about the impact that WTO entry would have on China have likewise proven to be wildly off the mark. China has not provided the market access that was expected, and central control of the economy appears to be rising rather than receding.

China has parlayed access to trade and foreign direct investment (FDI) into one of the greatest economic success stories in history. Since opening its economy, China has received more than $1.6 trillion in FDI, which has generated about one-third of its GDP and 27 percent of its employment, helping China to become the world’s largest exporter.

Yet China has managed to accomplish this without fully subscribing to the principles and spirit of the Western-constructed trade system, and without adhering to expectations that some measure of political loosening would accompany its economic growth and development.

Today, China projects a unique and formidable presence on the world stage: It has an immense economy and population, racking up increasing income levels and growing technological sophistication—all being orchestrated by an authoritarian central government pursuing a model of state-directed capitalism.

China’s dramatic economic ascent was not even remotely envisioned when the rules-based global trade system was first established. And since that time, no serious or comprehensive attempt has been made to update the rules in order to cope with and accommodate China’s state-directed model. These systemic deficiencies have laid the groundwork for many of the trade disputes playing out today, especially those involving industrial or technology policies, such as the “Made in China 2025” program and the “encouragement” of technology transfers from Western companies.

Western businesses in China have been largely willing to comply with, and even support, China’s policy strictures in exchange for market access and the prospect of substantial profits. In many instances, these companies became formidable domestic lobbies at home, counseling abeyance and patience in confronting China’s trade practices. That patience is now dwindling.

As trade confrontations escalate, there has been increasing concern over the possibility of a wider and prolonged period of strife between the United States and China. Such an outcome would be deeply undesirable. Trade wars and a widening of tensions serve no one’s interests.

But for now, both countries appear to be stuck in a dysfunctional conflict without any obvious exit ramps. Moving toward a much-needed accommodation, however, will require a clear-eyed and judgment-free understanding by the West of the profoundly important ways that China’s system and circumstances are different—and the unique capabilities those differences afford China as it engages its partners.

In reality, trade is only one side of what is actually a three-sided triangle. In addition to trade, two other elements—people and money—are also helping to support China’s ability to pursue national objectives and shape it relations—economic, trade, strategic, and diplomatic—with other countries and multilateral institutions.

Consider the “people” component. Chinese tourists and students—although usually not regarded as instruments of policy—are in fact important pieces of the puzzle.

As per capita income levels have increased over the last 20 years, the Chinese government has granted wider permission to travel abroad, and Chinese citizens have enthusiastically availed themselves of the opportunity.

The sheer numbers are staggering. A mere 4.5 million Chinese tourists traveled abroad in 1995, compared with 135 million in 2016—an increase of 2,900 percent. Today, no country in the world spends as much as China on outbound tourism. The $257 billion spent by Chinese tourists in 2017 was almost double that spent by Americans ($135 billion). To get a sense as to what those numbers might look like in the future, bear in the mind that roughly 92 percent of the Chinese population does not yet have a passport.

In a number of tourism-dependent localities, China is the largest source of tourism revenues. In Thailand for example, tourism generates more than 21 percent of national GDP, and China’s 9.8 million tourists pumped $16.3 billion into the kingdom’s economy—by far the largest contribution of any country. And those numbers are steadily on the rise.

For any China-dependent tourism destination, the prospect of losing those revenues would be devastating. What is unique about the current circumstances, however, is that the hand of the Chinese government rests firmly on the spigot, positioned to turn on or turn off the flow of Chinese tourists, essentially at will. A ban, or even just a limitation, placed on travel to a particular destination could inflict dire economic consequences. The potential leverage this could create in trade, investment, or economic and diplomatic relations should not be underestimated.

As a result of the economic significance of Chinese tourism and the ability of the Chinese government to control whether and where its citizens travel, China is the first country to be in a position to essentially “operationalize” tourism as a policy instrument if it so desires. Last year’s ban on group tours to South Korea, after that country agreed to install a U.S. ballistic missile shield, shows this power might be more than theoretical.

The influence generated by the number of Chinese students studying abroad is likewise noteworthy. Today, there are more than 350,000 Chinese students studying in the United States, an increase of 543 percent since 2000. China is by far the largest country of origin for foreign students in the United States, accounting for 33 percent of the total—almost double the second-largest country, India, with 17 percent. Chinese students pump $12.55 billion into the U.S. economy—a substantial figure that reflects the fact that foreign students at public universities pay tuition fees up to three times the level of in-state students.

China’s impact is felt not just through its one-third of a million students, but also through the funding it provides for teaching and research on China. As of 2017, China had funded 525 Confucius Institutes, which provide Mandarin training and courses on Chinese culture and history, in 146 countries, serving nine million students. It is estimated that China spends about $10 billion on funding Confucius Institutes around the world, and Chinese sources are also becoming major funders of leading U.S. think tanks and research organizations.

Between the tuition fees paid by Chinese students, as well as the financial support provided to establish university institutes or research programs, China now accounts for a substantial portion of revenues to major academic institutions in the United States and elsewhere. In Australia, for example, the auditor general in New South Wales has concluded that Australian universities actually face a “market concentration risk” due to the importance of foreign (principally Chinese) student fees.

As is usually the case, financial heft translates into influence. There have been numerous reports of universities canceling speaking events with participants who hold views contrary to Chinese policy, and professors and researchers are alluding to an increasing frequency of self-censorship for fear of offending Chinese sources of funding or jeopardizing their ability to conduct research in China.

China has accomplished something remarkable. It has placed itself in a position not only to extract world-class technological, scientific, and management know-how from the U.S. university system, but also to influence the tone and tenor of research and teaching on China issues.

China has also successfully utilized foreign direct investment—the “money” side of the triangle—to support its broader objectives, especially upgrading technological capabilities and improving geo-strategic positioning.

China is aggressively investing in technologies—particularly in the United States—that will be foundational to future innovation: artificial intelligence, autonomous vehicles, augmented/virtual reality, robotics, and blockchain technology.China’s investment in U.S. technology between 2006 and 2016 amounted to $35 billion and in 2016 alone was about $8.5 billion (although total Chinese FDI in the United States dropped off substantially in 2017).

While there is nothing unusual per se about investing in technology—it is a cornerstone of any country’s economic competitiveness—what is unique about China is the volume of money that comes directly from government or government-linked entities, or from private companies that receive investment capital from government sources that prescribe specific terms for how the capital is to be invested. This means that FDI is being largely deployed as an instrument of government policy, rather than as the result of discreet business decisions taken by independently functioning private companies.

Growing concerns in the United States over the implications of massive Chinese investment, especially in cutting-edge technologies, have led to an expansion of review procedures under the Committee on Foreign Investment in the United States (CFIUS).

Chinese investment and financing are setting off alarm bells in Asia as well. China’s Belt and Road Initiative is essentially a massive infrastructure build-out program, stretching from Southeast Asia through Central Asia to Europe. There is growing concern, however, that Chinese financing for infrastructure projects could ultimately prove to be “debt traps.”

Sri Lanka, for example, had to accede to a “debt for assets” lend-lease agreement with China in which it turned over the strategically important Hambantota Port for 99 years. Malaysia and Myanmar are now reviewing similar infrastructure investment arrangements they’ve entered into with China, citing concerns over national sovereignty.

Although China’s investment strategies now appear to be encountering some headwinds, its ability to procure technology and support geo-strategic aims remains substantial.

To be clear, none of these observations are intended to either laud or criticize China’s policies. The Chinese government is effectively maximizing the full range of tools at its disposal to help meet its national economic and geo-strategic objectives. Citizens of any country would hope that their national government would do precisely the same. To be fair, then, China’s policies need to be seen in the same context.

Likewise, none of these observations are intended as a commentary—either positive or negative—on China’s form of governance or its state-directed-capitalism model of development. These are issues which rightfully remain within the purview of sovereign nations to determine for themselves. Value-laden philosophical debates or attempts to shoehorn China into Western economic or governance models are a waste of time. China will continue to be China and needs to be dealt with as is.

Instead, the objective here is to draw into sharper relief a landscape which might not yet be fully in focus. The sheer size of China’s centrally planned economy, combined with its single-party system of governance, provides China with unique and formidable capabilities—not just in trade, but also in terms of people and money.

As China’s impact and influence continues to grow, points of friction with traditional free-market liberal democracies are, unfortunately, likely to grow as well. There is no alternative but to find a mutually acceptable mode of co-existence.

Policymakers in the ostensibly “free market, free trade” West fundamentally misunderstood China and the implications of integrating China’s state-driven economic system into the global trade system. Today, two decades later, moving constructively toward a workable modus vivendi between these different systems will require an unflinching understanding of the unique range of capabilities possessed by China—and the implications they hold for a trade system that never envisioned what China has become.

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Stephen Olson

Stephen Olson is a Senior Research Fellow at the Hinrich Foundation with over 30 years of international trade experience. Previously, he was an international trade negotiator in Washington DC and served on the US negotiating team for NAFTA negotiations.

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