This is not a trade war: A struggle for technological and geostrategic dominance

econstor Make Your Publications Visible A Service of zbw LeibnizInformationszentrum Wirtschaft Leibniz Information Centre for Economics Gros Daniel Article This is not a trade war it is a struggle for technological and geostrategic dominance CESifo Forum Provided in Cooperation with Ifo Institute Leibniz Institute for Economic Research at the University of Munich Suggested Citation Gros Daniel 2019 This is not a trade war it is a struggle for technological and geostrategic dominance CESifo Forum ISSN 2190717X ifo Institut LeibnizInstitut für Wirtschaftsforschung an der Universität München München Vol 20 Iss 1 pp 2126 This Version is available at httphdlhandlenet10419199024 StandardNutzungsbedingungen Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen öffentlich ausstellen öffentlich zugänglich machen vertreiben oder anderweitig nutzen Sofern die Verfasser die Dokumente unter OpenContentLizenzen insbesondere CCLizenzen zur Verfügung gestellt haben sollten gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte Terms of use Documents in EconStor may be saved and copied for your personal and scholarly purposes You are not to copy documents for public or commercial purposes to exhibit the documents publicly to make them publicly available on the internet or to distribute or otherwise use the documents in public If the documents have been made available under an Open Content Licence especially Creative Commons Licences you may exercise further usage rights as specified in the indicated licence wwweconstoreu 21 FOCUS CESifo Forum 1 2019 March Volume 20 Daniel Gros This is not a trade war it is a struggle for technological and geostrategic dominance IS THERE A CASUS BELLI FOR A TRADE WAR In many advanced countries the attitude towards US trade measures against China seems to be Trump is wrong in using blunt tools but he is right in pointing to a real problem But what exactly is the problem Is there a casus belli US complaints are often based on the large US external deficit Economists like to point out that trade balances have little to do with trade policy because a current account deficit is just the mirror image of an excess of domestic investment over domestic savings As long as trade measures do not have an impact on savings or investment they will not affect the current account balance But even abstracting from these considerations it is difficult to find a rationale for a USChina trade war given that the current account surplus of China has disap peared as shown in the last column of the Table 1 Trump himself often motivated his actions with trade instead of current account balances Looking at trade imbalances yields a somewhat different pic ture than current accounts especially if one focuses on trade in goods which seems to be the metric pre ferred by the US president himself For example on goods first two columns in Table 1 one finds that the US deficit is very large at USD 750 billion 4 of US GDP while both the euro area and China have very large surpluses worth more than 4 of GDP whereas Japan does not figure anymore This implies that even viewed from this angle there is no reason for the United States to focus on China Trade in services columns 3 and 4 in Table 1 shows the relative strength of the United States in this sector The United States has a surplus of USD 250 billion while China is running a deficit on services mainly tourism of the same magnitude However the United States receives only a part of Daniel Gros Center for European Policy Studies Chinese tourism which leaves the bilateral bal ance on goods and services deeply negative Econ omists tend to focus on the current account last columns in Table 1 which besides goods and ser vices also includes capital income On this mea sure China is no longer a part of the problem as its current account surplus has essentially disap peared Global imbalances have become a trans atlantic issue as the deficit of the United States is mirrored in a surplus of the same size for the euro area In terms of trade imbalances it is thus difficult to find a casus belli against China unless one focuses on bilateral balances in goods But in this case the trans atlantic dimension is equally important DOES CHINA PROTECT AGAINST IMPORTS One argument for the United States to focus on China could be that the euro area is running a large trade surplus but at least has open markets whereas the trade surplus of China could be due to protectionism But even this argument does not stand up to scrutiny The standard tool of protection ism is tariffs On this front the problem seems very limited The average tariff rate applied by China has continue to fall even after its entry into the WTO in 2001 which had already forced the country to re duce tariff protection by one half Indeed the ave rage applied tariff now seems to have fallen to less than 4 and there are few complaints about tar iffs even though China maintains an unusually high number of tariff peaks ie high tariffs for very limited product categories A CEPS study finds that Chinas tariff schedule contains an unusually high number of tariff peaks But these high tariffs affect only prod ucts of limited relevance Moreover tariff peaks are not even on the list of complaint of either the United States or the EU Tariffs were in any case yesterdays problem until Trump dusted them off as a weapon for his trade war But they provide one clear numerical indicator of obstacles that traders in goods might encounter at the border There are many other ways to create obstacles to trade It is difficult to measure the over all importance of these nontariff barriers to trade because they can consist of so many different mea sures including licensing conformity assessment etc These nontariff measures are difficult to keep Table 1 Trade and current account imbalances Net balances 2016 Current account 2018 Goods Services USD billion GDP USD billion GDP GDP US China Euro area Japan 753 494 487 51 40 44 41 10 248 244 65 11 13 22 05 02 25 03 35 37 Source World Bank Table 1 22 FOCUS CESifo Forum 1 2019 March Volume 20 track of because they usually concern only a specific sector or product However the website of the Global Trade Alert Observatory has since 2008 provided an excel lent running observatory of new measures called state interventions introduced by major trading nations For China this independent body finds only around 25 new measures that might restrict trade with the United States annual average since 2008 Interestingly China also enacted about the same number of new measures that have the effect of liberalizing trade with the United States China has thus not become more protectionist against the United States The other way around the situation looks very different the United States has enacted be tween 80 and 100 or about 4 times more restric tive measures against China which far outstrip the much less numerous liberalizing measures Moreover as illustrated in the Appendix one finds a similar asymmetry between Germany and China in recent years China has introduced about as many liberalizing as protectionist measures But Germany has taken mostly protectionist measures visàvis China This means that in terms of trade measures China is being more sinned against than it is sinning itself One could of course argue that protection against Chinese exports is needed because export ers there receive subsidies This is one point on which the complaints seem justified When China joined the WTO it took on the obligation of notify ing the phaseout of a number of existing subsidies and notifying all those that continue Annex 5a and 5b to the Accession Protocol However this soft commitment was not honored In late 2018 China suddenly sent a notification to the WTO for all the missing prior years However it seems that these notifications were incomplete as found in the latest WTO Trade Policy Review In principle the United States and Europe could offset the advantages that these more or less hidden subsidies give Chinese exporters by introducing countervailing duties In practice this is difficult because the opaque nature of the subsidies makes it difficult to prove their im pact in specific cases STATEOWNED ENTERPRISES The case for countervailing action would be justified in particular in the case of exports by stateowned enter prises SOEs This might have been a problem in the past when SOEs accounted for one half of exports But now their share of overall Chinese exports has fallen to less than 101 Despite their now very limited importance for trade SOEs consti tute another bone of contention between China and the West This has of course little to do with trade policy since SOEs are just one element of the eco nomic order in China As mentioned SOEs do not play a large part in Chinese exports and if they practice unfair pricing the problem can be dealt with by tradi tional countervailing duties and other measures The real complaints about SOEs relate to the structure of the Chinese economy Complaints from the European Chamber of Commerce in China con cern the preferential treatment given to SOEs mostly in nontradable sectors like financial services etc Of course the dominance of huge stateowned banks creates the temptation to favor SOEs in the allocation of credit But a lack of access to cheap credit should not be a problem for foreignowned or invested companies which usually have a major multinational enterprise with access to global capital markets behind them Private Chinese enterprises ought to be equally or perhaps even more disadvantaged by SOEs having preferential access to capital The role of SOEs in the Chinese economy is diffi cult to document in detail but most statistics suggest it remains important albeit having fallen somewhat over the last two decades For example SOEs still account for about half of the capital stock of indus trial enterprises down from three quarters More over SOEs tend to be large A number of them espe cially the large stateowned banks now rank among the largest global companies But these examples are not representative of the entire sector SOEs remain an important factor in the Chinese economy but their importance has declined considerably over the last decade and more recently For example SOEs now account for only about one quarter of urban employment and a sim ilar share of profits and only one tenth of exports 1 There is one exception that proves this rule The Chinese Railway Corporation which is of course vastly larger than any other railway company in the world has spent heavily on RD allowing it to be come an important exporter of trains and material China alone now accounts for one half of all global trade in this sector But this sector is not typical of overall Chinese trade patterns Source Geneva Initiative Number of new interventions implemented each year US and China China on imports from United States Discriminatory Liberalising United States on imports from China ifo Institute 2009 2011 2013 2015 2017 2019 0 13 25 38 50 0 40 80 120 160 2009 2011 2013 2015 2017 2019 Figure 1 23 FOCUS CESifo Forum 1 2019 March Volume 20 as mentioned above Foreigncontrolled enterprises make more profits 31 of the total while the share of profits going to private Chinese enterprises is even higher Chinese statistics show that foreigninvested enterprises generally achieve much higher profitabil ity than stateowned ones and that the profitability of foreigninvested enterprises has persisted not fallen over time although it remains slightly lower than that of private Chinese ones There is thus evi dence that while SOEs are not efficient in their in vestment they play only a small role in exports and their continuing role has not impeded continuing high profitability of foreign investment in China Some observers have detected a revival of the role of SOEs more recently but the evidence for this is still tentative2 THE REAL PROBLEM IS FDI The finding that there is no casus belli for a classic trade war is confirmed if one looks carefully at the complaints enumerated by the United States or at the detailed report published by the European Chamber of Commerce in China summarizing the complaints from its over 1600 member companies This report makes interesting reading because one does not find many complains about trading practices at least in the narrow sense The main complaint of EU enter prises in China is the perception of unfair treatment by the Chinese authorities The main complaint of the US government is that US hightech firms are forced to reveal their technology and trade secrets An addi tional common complaint is that in many sectors for eign firms are not permitted to hold a majority stake in joint ventures The core of all these complaints is thus not trade but FDI and the situation behind the border in the Chinese market Measuring barriers to FDI is as difficult as measur ing nontariff barriers to trade Barriers to crossbor der investment can take many forms such as limits on foreign ownership in certain sectors different fiscal treatment for foreignowned enterprises or outright bureaucratic discrimination The OECD publishes a composite indicator of restrictiveness towards FDI For China this indicator shows that overall the coun try is far less open than OECD countries but that there has been continuous albeit slow improvement A further subtle distinction one needs to make is that between barriers to new inflows of direct invest ment ie investment with the implication that the foreign investor obtains control over the investment and the treatment of enterprises that are under for eign control In most OECD countries a company incorporated in a different home country is treated in 2 The data for 2017 shows an unusual jump in the profits of SOEs while those of private Chinese enterprises fell It is too early to tell whether this is the result of a reclassification or other statistical adjustments the same way as any other domestically incorporated company this is called national treatment But in China there is a special regime for foreigninvested enterprises In the past the purpose of this special regime might have been to protect foreign inves tors from an overbearing domestic bureaucracy But today there is a widespread perception that for eigninvested enterprises are not treated fairly The complaints have come in the light of the rapidly changing context in China itself The real change might simply be that in the past the formal handicaps that foreignowned enterprises faced were compensated by the eagerness of the provin cial authorities to attract foreign investment As long as provincial leaders were also judged on the amount of FDI they attracted they would provide many incentives to outweigh the formal restrictions on FIEs Today there is less emphasis on growth in the evaluation criteria of provincial leaders which means local authorities have less reason to provide incentives for FDI Moreover the technology gap between Chinese and foreign enterprises is shrinking rapidly in many sectors Restrictions on majority foreign ownership mattered little in the past when the formally major ity Chinese partner often owning 51 percent had an incentive to acquiesce to the de facto control of a foreign investor who had superior technology or market access abroad With technology on a more level playing field it is the uneven playing field as to restrictions on foreign majority ownership that starts to matter This is also the reason why it is more appropriate to speak about a technology war than a trade war FORCED TRANSFER OF TECHNOLOGY A CASUS BELLI Exhibit one in the complaints about Chinese unfair practices is what the US authorities call forced trans fer of technology The term forced suggests a degree of coercion that does not make economic sense A US company can always choose not to invest in China If a US or European company chooses to invest in China despite the requirement to transfer technol ogy it does because it expects to make a profit That profit might be smaller than it would have been with no technology transfer requirement but the choice of going into China anyway reveals that the company sees more opportunities than risks Moreover the Chinese partners for example in a joint venture know that the foreign investment will come with a technology transfer This means that the local partners will be ready to accept that the valua tion of the foreign investors contribution to a joint venture includes the value of the transfer of tech nology For example the local partner or the local government can provide cheap land infrastructure tax exemptions or loans on favorable terms In other 24 FOCUS CESifo Forum 1 2019 March Volume 20 words the transfer of technology because it is the rule will be priced into any FDI deal The continuing high profitability of foreigninvested enterprises sug gests that this has indeed been the case It is only natural that American and European companies will assert in surveys that they would be better off if they had not been forced to transfer technology However these statements do not take into account the fact that the terms on which the ini tial investment was made probably contained advan tages that were available to the Western investors only because of the expectation of technology trans fer It is of course likely that in many cases the most efficient investment deal would not have involved a wholesale transfer of technology but perhaps only a licensing agreement or the payment of royalties However that should be only a secondary consider ation since the present value of the foregone licens ing fees or royalties would have figured implicitly in any investment deal It is often impossible to prove the pressure exerted by Chinese author ities to transfer technology because China made a formal undertaking when it entered the WTO that it would no longer require technology transfers3 However because of this WTO undertaking it seems that the pressure to make technology transfers has become informal Accord ing to many observers the Chinese authorities even avoid 3 See the Chinese WTO Agreement Also in Annex 1 of the Protocol China pledged to abolish technology transfer requirements in order to comply with the WTO Traderelated Investment Measures TRIMSbut that is only with regard to trade in goods emails that could be used as proof instead giving only indi rect oral hints It is thus likely that in reality this pressure to transfer technology does persist HAS FORCED TECHNOLOGY TRANSFER AFFECTED PROFITS However as argued above FDI inflows should continue only if it remains in the interest of foreign enterprises to invest in China knowing in advance that the pressure to transfer technology will exit but might be offset by other advantages The confirmation of this reason can be found in the rates of return on FDI in China these have remained high as can be seen from different angles Chinese statistics themselves report the rate of return on for eigninvested stateowned and private domestic enterprises Figure 2 shows the profit rates of these three groups since China joined the WTO The rate of return on FDI as measured by Chinese statistics has in fact tended to increase slightly over time It reached a natural peak during the Chinese boom of 2010 but at around 8 it remains much higher than that of SOEs around 3 The profitability of private Chinese enterprises is somewhat higher than that of foreign ones but the difference has narrowed recently to about 2 percentage points Another indicator is the profitability as seen from the home country Figure 3 shows the profitability of FDI for the EU The average rate of return on outgoing FDI is somewhat below 5 under 3 for EU invest ment in Canada and the United States but 10 for 0 2 4 6 8 10 12 14 16 2001 2003 2005 2007 2009 2011 2013 2015 2017 SOEs Privat domestic FDI Source Chinese Statistical Yearbook Profit rates in China ifo Institute Figure 2 47 23 29 43 101 68 89 72 0 2 4 6 8 10 12 ExtraEU 28 Canada United States Brazil China Russia Japan India Source Own calculations on the basis of Eurostat data Average rate of return on FDI 20142017 ifo Institute Figure 3 25 FOCUS CESifo Forum 1 2019 March Volume 20 investment in China China seems to offer by far the highest rate of return among all the major destina tions for EU direct investment abroad The problem with the FDI statistics is that almost none of the FDI from OECD countries to China goes directly into that country In both the US and the EU statistics the share of foreign direct investment going to China is less than 4 less than for Brazil for exam ple This is why one has to take the balanceofpay ments FDI data with a big grain of salt4 All these considerations suggest that the cost of forced transfer of technology for US and other Western hightech companies might be vastly exag gerated But the argument also applies the other way around Why should China continue to insist on this policy of linking market access for foreign investors to a transfer of technology The key official argument on the Chinese side is that in a developing country the local companies are in a weak position visàvis for eign investors whose technology they might not fully understand This argument is also used in many less developed countries whose FDI regimes are often as restrictive as that of China However the argument that China is a develop ing economy that deserves special exemptions from WTO rules becomes less and less tenable as the coun try develops its own technological expertise Chinas indigenous capacities for research and development have literally exploded over the past few decades Spending on RD is now larger as a percentage of GDP and larger in absolute terms than in Europe and many other OECD countries Today there is thus little need to protect Chinese infant industries Rapidly advancing domestic knowhow and the absorption of technology also explain why Western complaints have become more vocal Many Western firms probably agreed to a transfer of technology under the assumption that Chinese competitors would anyway not be able to adapt and master it Part of todays complaints stem from the fact that this expectation of superiority has been confounded China produces more bachelor graduates in science and engineering than the United States and Europe combined One reason why the Chinese authorities remain so reluctant to give up on their technology transfer policy is that they are making a mirrorimage mistake to the United States they overestimate the impact of informal state intervention to foster the transfer of technology They fail to see that Western companies will take this policy into account when deciding on investments in China offering worse terms than if they were able to keep their technology and use licensing agreements instead Moreover these other forms of technology transfer are becoming more and more widespread with the result that recorded royalty 4 Data on greenfield projects assembled by UNCTAD shows a very different picture regarding the distribution of FDI but this source has no information on the profitability of these projects payments from China have grown very quickly and now amount to close to USD 30 billion per annum putting China second only to the United States in the league table of paying for foreign technology This shows that a large and increasing share of technol ogy transfer has not been forced Very recently late December 2018 the government of China announced that it would abolish those administrative measures that result in de facto forced technology transfer It remains to be seen whether this new policy will actu ally be implemented across the many different layers of government involved central provincial and local governments many different ministries etc CONCLUSION An outright trade war between the United States and China in the sense of both sides imposing stiff tar iffs on each others imports remains unlikely How ever tensions between the two countries are likely to persist President Trumps tough stance on China remains popular in the United States not so much due to the bilateral trade deficit or frustration about lost business opportunities but because of the concern that China is about to outcompete the United States for technological leadership in a number of sectors considered critical for national security on both sides of the Pacific The reason SinoUS tensions on FDI and the associated forced transfer of technol ogy are so intense is because they are mostly about income distribution between two monopolists The Chinese authorities hold the key to access to a vast and quickly growing market whereas Western com panies still have a monopoly on the best technology in many sectors The United States and China account for a large share of global trade but they alone do not dominate the global economy In the coming cold economic war the side that can obtain the support of neutral powers will have a strong advantage Other large trading powersEurope and Japan for exampledo not share the US desire to keep China down and are thus unlikely to back unreasonable trade measures However Europe and Japan share the narrower US concerns about an uneven playing field generated by persistent Chinese state intervention in the economy It is up to the Chinese authorities to allay legitimate concerns about these issues which go to the heart of a global rulesbased trading system The Chinese economy is now so strong that restrictions on foreign ownership and any form of forced transfer of technol ogy are no longer needed 26 FOCUS CESifo Forum 1 2019 March Volume 20 APPENDIX MARKET DISTORTING MEASURES GERMANY VS US AND GERMANY VS CHINA Across the Atlantic one finds a rough equivalence of measures if one takes Germany to represent Europe The absolute number of measures is somewhat greater for the United States about twice as many see the dif ference in scale in Figure A1 But this is understand able given the countries relative difference in size However if one looks at Germany visàvis China one finds a similar asymmetry to that between China and the United States for China the number of liberalizing measures roughly equals the number of protection ist ones But Germanys measures affecting China are more commonly of the protectionist kind Source Geneva Initiative Number of new interventions implemented each year US and China United States on imports from Germany Discriminatory Liberalising Germany on import from United States Germany on imports from China China on imports from Germany ifo Institute 2009 2011 2013 2015 2017 2019 0 13 25 38 50 0 40 80 120 160 2009 2011 2013 2015 2017 2019 2009 2011 2013 2015 2017 2019 0 13 25 38 50 0 40 80 120 160 2009 2011 2013 2015 2017 2019 Figure A1