rethinking U.S. Economic Policy Toward China

By Leland Miller

American (and other) policymakers have for years debated whether the United States and China are destined to cooperate, compete, or fall to conflict. But the question is unhelpful, because it invariably has two distinct answers. In the economic sphere, strong U.S.-China relations will be critical for both countries and the world—and remain, in the aggregate, mutually beneficial. In the security realm, however, a China that continues to view the status quo as a constraint to its rise poses a growing threat to U.S. interests and those of its allies. So long as this endures, geopolitics will remain much closer to a zero-sum game.

Any constructive framework for managing U.S.-China relations must recognize and incorporate the reality of these two conflicting dynamics. Otherwise, with the strands in constant tension, U.S. policy toward China will continue to be mired in confusion, alternating between shows of geopolitical weakness and hardline economic postures that do us more harm than good.

The next Administration’s China policy should therefore be grounded in two key precepts: First, U.S.-China policy should be viewed through a wider lens that better identifies and prioritizes core American interests—and is more assertive in protecting them—rather than wasting precious resources fighting trivial policy battles simply to appear anti-China; and second, while Washington should continue to integrate and coordinate its economic and security policymaking, great care must be taken not to blindly merge their execution. This will require a disciplined approach that combines tactical assertiveness in each area with “strategic ring-fencing,” forcing policy to be judged by its effectiveness rather than by its headline-grabbing power.

Getting U.S. China policy right is more than just an academic issue. The current Administration’s inability to pick its battles wisely (and both parties’ confusion over how best to wage them) has led our Asian allies to question U.S. leadership, as well as America’s long-term commitment to regional stability. Too often, it has also let China off the hook for serious violations of international norms. The next Administration will have a fresh opportunity to right this ship—but only if it comes to terms with just how badly, and unnecessarily, we have been causing it to founder.

The starting point for developing a sound U.S.-China policy is to recognize that policy priorities should be dictated by core U.S. interests, not perceived Chinese misbehavior. The United States can’t right every Chinese wrong, and an inability to properly identify appropriate action areas has been a shortcoming of U.S. policy for years. However, 2015 represents an extreme case study in policy chaos. While the roots of the problem extend far beyond any single issue, the failings of the Obama Administration’s China strategy can best be understood through its disjointed approach to two aspiring Asian institutions: the Asian Infrastructure Investment Bank (AIIB) and the Trans-Pacific Partnership (TPP).

The AIIB, founded by China during this past year, is a multilateral investment bank created ostensibly to fund infrastructure projects across the Asian region. While its creation partly reflects China’s frustration with its relatively meager influence inside global institutions such as the IMF and World Bank, its raison d’être is far more practical: Amid both slowing exports and faltering demand at home, China sees the AIIB as a vehicle for recycling its huge capital surpluses abroad via development loans, with the goal of generating greater foreign demand for Chinese goods and services.

“Countering” the AIIB should never have been a first-tier policy issue for the U.S. government. First, we have no significant interest in competing for these infrastructure opportunities, which are not objectively attractive except to a Chinese economy increasingly desperate to subsidize new sources of demand. Second, the amount of money at play is very modest; China is contributing just over $29 billion of the initial $100 billion capital base, an amount substantially less than it has provided Venezuela directly since 2008. Lastly, but most telling, China already has a long (and disappointing) track record of conducting precisely these types of activities unilaterally through its state-run policy banks. The largest of these policy banks, China Development Bank, issued more than a half trillion dollars in questionable loans and grants over the past decade alone. AIIB is not a dangerous new Chinese weapon, but rather the continuation of an immensely inefficient state-run economic strategy scrambling for new sources of growth.

While policymakers should closely monitor the soft power implications of AIIB’s activities, remarkably little of the Administration’s bandwidth should have been required for that purpose. Yet that is not how things played out. Devoid of a framework for assessing the bank’s relative importance within the overall U.S.-China relationship, the Administration went on the attack, lashing out at close allies such as Australia, South Korea, and Britain, first in private and then (anonymously) in the Financial Times, accusing them of “constant accommodation of China.” Missing was any coherent rationale for taking this stand, or any serious argument as to why U.S. allies should gratuitously antagonize Beijing, beyond a hazy notion of “sticking it” to China.

Is the U.S. government really “containing” Chinese power by trying (and failing) to undermine Beijing on a regional infrastructure bank? Is this truly an issue where U.S. power and prestige should have been invested in the outcome? Obama Administration policy constituted a foreign policy debacle not just because it undercut U.S. credibility and damaged our relationships with key allies, but also because it foolishly elevated a third-order issue like AIIB into a major foreign policy coup for Beijing. We scored on our own goal.

An even more frustrating example of the Administration’s approach to China has been its long-term disinterest in a matter of far greater importance to U.S. leadership in Asia: the Trans-Pacific Partnership (TPP). Nearly a decade in the making, TPP is a global free-trade pact led by the United States and 11 other nations, including Japan, Vietnam, Brunei, Singapore, Malaysia, New Zealand, and Australia. Encompassing roughly 40 percent of global output, TPP will lower tariffs in previously impenetrable Asian markets such as Japanese agriculture and Southeast Asian services, while also establishing rules for trade dispute resolution and the protection of intellectual property. Few platforms could better signal a sustained U.S. commitment to Asia: U.S. standards are the bedrock of TPP, and U.S. political and economic leadership are its foundation. Moreover, the hope is that TPP will ultimately serve as the precursor to a true (U.S.-led) pan-Asia free trade area.

TPP should have been the cornerstone of the Administration’s Asia strategy from day one. In 2012, when President Obama announced his “pivot” to Asia, he himself noted that there cannot be such a pivot without economic and trade underpinnings, and TPP was nearly a ready-made solution. The geopolitical implications of TPP are similarly compelling, as the pact would in effect create a parallel economic alliance structure intended to cement and deepen longstanding U.S. security and defense relationships.

If America does not wish to lead in Asia, China stands ready to fill the vacuum.

Until just a few months ago, however, the TPP was nowhere on this Administration’s agenda. In order to pass TPP, the White House had to first secure Trade Promotion Authority, known as “fast track,” a power sought by every President since FDR that allows him to submit a negotiated treaty to an up-or-down vote in Congress. The White House had six full years to push for TPA, two of which featured Democratic control in Congress and the other four when its partner was a GOP House eager to coordinate a TPA/TPP push. Yet not until 2015 did the Administration expend even a modicum of effort to push it forward—a sin of omission that very nearly led to its demise. TPA legislation passed in June on its second try, by only the slimmest of margins and against the fierce opposition of the President’s own party. TPP, meanwhile, is now foundering, the expected “deal-cinching” July negotiation round ending in failure after signatory countries found themselves unable to scramble together an agreement on the now-hurried timeline the White House pushed forward.

Why would an Administration blow U.S. prestige on a third-order issue like AIIB while risking the President’s own legacy by ignoring TPP for more than half a decade? Many pundits blame politics for the TPA debacle, despite the fact that the White House dictated both the timing and the script for eventual engagement. Many similarly blamed a lack of so-called China experts in the Administration for the AIIB mess. But these were not merely political missteps. They were either massive management fiascos or, just as likely, strategic ones.

Whatever the sources of the failures, Asia will not wait for America to get its act together. In 2015 alone, China has signed free-trade agreements with both Australia and South Korea, while it continues to push forward the Regional Comprehensive Economic Partnership (RCEP), a China-led trade bloc considered a rival to TPP because it includes seven Asian countries (five in ASEAN) that are also TPP signatories. If America does not wish to lead in Asia, China stands ready to fill the vacuum.

As chapter 5.3 argues, China has become ever “more open in challenging key elements of the existing order in Asia.” And this path’s trajectory looks even more troubling to U.S. interests on the horizon, as Beijing grows closer to declaring an Air Defense Identification Zone (ADIZ) over the South China Sea, Taiwan enters a presidential election year, and Chinese cyber hacking of U.S. companies approaches a boiling point.

The U.S. government needs a revamped approach to U.S.-China policy, but not one that stresses greater reliance on economic and trade policy as a means of retribution.

To confront these challenges the U.S. government needs a revamped approach to U.S.-China policy, but not one that stresses greater reliance on economic and trade policy as a means of retribution. This idea, which has been making the rounds in Congress and elsewhere, implies that such a tactic constitutes either a less costly or more effective way to address China’s aggressive behavior. Both are deeply flawed assumptions, however, and to the extent they remain unchallenged, a new Administration may mistakenly believe it wise to forgo conventional military deterrence and instead rely primarily on its economic toolbox for solutions.

This notion, therefore, merits a more detailed critique. Acts of economic warfare—be they raising tariffs on Chinese goods, threatening to fling “currency manipulation” labels about, or barring China’s inclusion in global trade pacts—typically represent ineffective and counterproductive U.S. policy responses. This is so for two key reasons. First, they will boomerang in such a way as to harm American interests as much as or more than those of China—which is certain to escalate and in any case can better mitigate short-term damage to its state-controlled economy than we can to our less centralized one. Second, they will not disincentivize aggressive Chinese behavior but will almost certainly have the opposite effect. In today’s world China holds a comparatively stronger hand in economic matters than it does in the security realm; by relying on economic tools to guide outcomes, Washington would effectively be ceding leverage to Beijing over how these disagreements are settled.

With economic warfare largely off the table, then, what type of deterrence is appropriate? The answer is that security threats merit traditional, security-related solutions.  If China declares an Exclusive Economic Zone (EEZ) in international waters, the U.S. Navy should sail through it, not raise tariffs on Chinese ships. If Chinese naval actions threaten allies such as Taiwan or the Philippines, the U.S. government should sell state-of-the-art weaponry, not threaten to torpedo China from trade talks. As noted in chapter 5.2, the United States retains strong advantages in the security realm, and it should not be eager to shift the policy battlefield when conventional deterrence continues to offer the highest ground.

Beyond the general problem—the muddying use of economics-based tactics for security-related issues—the most widely discussed of these tactics merit further analysis. The idea of raising tariffs on Chinese goods is a good place to start.

In 2013, the Blair-Huntsman Commission proposed responding to Chinese cyber intrusions with an “across the board tariff on Chinese goods,” an idea that was surprisingly seconded by a recent Council on Foreign Relations task force charged with re-assessing U.S. policy toward China. While these groups should be lauded for articulating an actual program of deterrence, raising tariffs on Chinese goods—or even threatening to do so—happens to be a spectacularly poor idea, for three major reasons.

First, the obvious: China will inevitably respond to the raising of U.S. tariffs with exclusionary efforts of its own, harming U.S. interests and threatening escalation to a broader trade war.

Second, the proposal betrays a flawed understanding of trade economics, under which imports are viewed merely as gifts bequeathed to foreign countries for good behavior rather than critical inputs to a well-functioning American economy. Imports such as steel, auto parts, and textiles—among many other key inputs—allow U.S. firms to produce more competitively priced end products, while cheaper consumer goods improve the quality of life for American families. Far from helping the average American, tariffs serve as a regressive tax on consumers that ends up hurting the poor the most.

Third, and often overlooked, this approach may actually create a Chinese incentive for escalation. Compared to the U.S. political system, where any tariff-raising would certainly be subject to a fierce congressional tug of war, Chinese leaders can opt to raise tariffs or bail out injured parties with the mere stroke of a pen. This incongruity is not lost on Beijing, meaning the chances of miscalculation will increase if Beijing’s game theorists believe that a U.S. Administration cannot make good on its threats—or match any ensuing escalation. (After the recent debacle over TPA passage, could anyone possibly blame them?)

U.S. interests lie not in punishing China by economic means but rather in incentivizing it to improve its game.

What about accusations of currency manipulation? Many politicians in both parties still believe that it serves U.S. interests to label China a currency manipulator, an argument that has become more heated in the aftermath of China’s modest yuan devaluation in August. But it would not serve our interests. To begin with, we face a practical problem: There is no agreed-upon way to assess the true market value of the yuan short of liberalization. According to the Congressional Research Service, from 2005 to 2013 the yuan appreciated 34 percent against the dollar in nominal terms and 42 percent in real terms. At what precise point does its value become “fair”? The IMF itself declared the yuan “fairly valued” this past May.

Furthermore, the second claims linking a cheaper yuan to U.S. unemployment are specious.  Before the 1994 yuan devaluation, the U.S. jobless rate was 6.5 percent; after the devaluation, it fell steadily to below 4 percent. In 2005, China again began to strengthen its currency, and yet the U.S. economy deteriorated. There is no historical link between the yuan’s value and U.S. unemployment levels.

Lastly on this point, it is curious to see this argument voiced in today’s economic climate, during a time when China’s government may be the only major one in the world actively resisting “currency wars.” In an apparent break from reality, the U.S. Treasury Department left this June’s Strategic & Economic Dialogue heralding a new pledge by Beijing not to intervene except when “necessitated by disorderly market conditions”—ignoring the fact that China’s central bank has kept the yuan strong over the past year only by intervening to strengthen it, a dynamic made crystal clear when such controls were loosened in August. So what is the verdict here? Should Congress censure Beijing, or send it a fruit basket?

U.S. interests lie not in punishing China by economic means but rather in incentivizing it to improve its game. Thus, for example, China’s command economy is nowhere close to qualifying for membership in TPP due to the agreement’s high standards, and under no circumstances should the rules be loosened in order to facilitate its inclusion. But should China, at some future date, conduct the necessary reforms to qualify, it is in America’s interest to keep the door ajar—and there is every reason to make that clear to the Chinese leadership.

Trade agreements like TPP are built upon U.S. standards, with U.S. political and economic leadership as their foundation; any future China membership would solidify such power structures, not undercut them. Notably, TPP will include limited, but valuable, disciplines on state-owned enterprises (SOEs)—for example, on transparency and non-discrimination—that are directed specifically at economies like China’s. Bringing Beijing inside the tent of global best practices will help American firms compete.

Moreover, even skeptics should recognize that articulating an exclusionary policy toward China invariably does more harm than good. Welcoming China’s future participation may or may not incentivize reform, but it would undermine Beijing’s paranoid narrative that TPP is intended as an anti-China alliance, helping ease the future accession of our allies in Korea, Taiwan, and across Southeast Asia.

That said, while broad economic warfare rarely serves U.S. interests, targeted economic solutions—such as tighter export controls on sensitive technologies or sanctions on individual companies or persons that break U.S. laws—can serve U.S. interests. The Blair-Huntsman report offers some excellent proposals in this regard, particularly for combating the theft of intellectual property (IP): denying products that contain stolen IP access to the U.S. market; restricting use of the U.S. financial system to foreign companies that repeatedly steal IP; and revising the approval guidelines for approval by the Committee for Foreign Investment in the United States (CFIUS) and for foreign companies listed on U.S. stock exchanges.

The U.S. government should also consider more aggressive action on subsidies and IP at the World Trade Organization (WTO), where China has a surprisingly strong record of complying with adverse decisions. Not doing foolish things with our economic levers does not preclude doing appropriate and even wise things with them.

America must have the discipline to respond to any aggressive Chinese actions using the appropriate levers—which means treating security threats as security issues, enforced by the U.S. military, not problems that can be wished away into the economic realm

The framework articulated here represents a rather dramatic rethinking of traditional U.S.-China policy doctrine, but its application is long overdue. Experts have been too slow to recognize that the old rhetorical divide between China hawks and doves no longer applies readily to a relationship where U.S. economic interests can suffer greatly from ill-advised anti-China protectionism, but U.S. geopolitical interests can suffer even more severely from security policies that signal a lack of resolve. We urgently need an integrated approach that emphasizes tactical assertiveness in each of these areas but does not blur the categories to our own detriment—namely, “strategic ring-fencing.”  The goal should be to optimize U.S. leverage and outcomes while refusing to allow populist or simply foolish impulses to dictate national strategy.

The next Administration’s China policy must attack this challenge head on. America should categorically identify its core interests and act steadfastly in their defense, while avoiding wasting political and diplomatic capital chasing down resolution on second- and third-tier issues. Once priorities are properly identified, America must have the discipline to respond to any aggressive Chinese actions using the appropriate levers—which means treating security threats as security issues, enforced by the U.S. military, not problems that can be wished away into the economic realm, where they nearly always do Americans more harm than good.