“Stop engine!”

“Stop engine! Oi! Tomare!” (Hey! Stop!) “Oi! Tomare! TOMARE!”

A loud bang resounded as the trawler plowed into the Mizuki, sending black smoke billowing from the point of impact. Although nobody was injured, the collision dented the patrol boat and damaged a railing. Shortly thereafter the trawler was chased down and boarded by Japan Coast Guard personnel, who took the crew and captain, 41-year-old Zhan Qixiong, into custody.

The events that followed sent a jarring message to the world about how China might wield the power accorded by its burgeoning economy. In foreign capitals where China’s growth was beheld with a mixture of awe and disquiet, Beijing’s response to the ship collision ratcheted up the level of anxiety.

At first, Chinese anger over Japan’s actions manifested itself in sharp diplomatic protests and demonstrations by groups of citizens aroused by memories of Japanese imperialism. Contending that the trawler had the legal right to fish in waters deemed by China to be its own, Beijing denounced the detention of the ship and crew as “harassment” and demanded their immediate release. Although Japanese authorities allowed 14 crew members to return to China on September 13, Captain Zhan remained confined in an Okinawa police station. The possibility of Tokyo lodging formal charges against the captain drew Chinese warnings of “strong countermeasures” and the suspension of bilateral exchanges on issues ranging from aviation to coal. Then, two weeks after the collision, the stakes rose exponentially.

On September 22, The New York Times reported that Beijing was blocking exports to Japan of rare earths, over which China held a near-monopoly of the world supply. These minerals, such as neodymium, samarium, praseodymium and cerium, are crucial in the manufacture of high-tech products including hybrid cars, smartphones, guided missiles, low-energy lightbulbs and camera lenses — and Japanese companies were almost totally dependent on Chinese imports. Industry sources told the Times that Chinese customs officials had notified exporters to halt shipments to Japan of pure rare earths or rare-earth oxides and salts, although shipments to other countries were still permitted.

Chinese officials publicly denied that they were singling out Japan, and some evidence indicates that supply problems afflicting Japanese companies stemmed from a more general policy that Beijing had adopted earlier in 2010 reducing rare-earth exports to all countries. But other news reports bolstered claims that Japan was being targeted for an embargo subtly orchestrated by powerful Chinese policymakers, and US officials said later that they had received private confirmation. Facing an apparent threat to strangle advanced sectors of its economy, Tokyo quickly backed down in humiliating fashion, releasing Zhan on September 24 to fly home on a chartered plane sent by the Chinese government.

Among the most influential alarms sounded abroad was that of economist Paul Krugman. “I find this story deeply disturbing,” Krugman wrote in his New York Times column, noting similarities between Beijing’s behavior in this case and its increasing tendency for crafty manipulation to favor Chinese firms. “China … showed no hesitation at all about using its trade muscle to get its way in a political dispute, in clear — if denied — violation of international trade law.”

A chilling question thus arose: had the rule-making club for the global trading system admitted an economic superpower that was going rogue?

Nine years before the ship collision, China joined the World Trade Organization (WTO), a historic integration into the global economy of the world’s most populous nation at a time when it was rapidly shedding vestiges of Maoist totalitarianism. The WTO, then as now a subject of considerable controversy, is the single most important institution in preserving and advancing economic globalization; it is the current embodiment of the system established after World War II to prevent a reversion to the protectionist horrors of the 1930s. WTO rules keep a lid on the import barriers of member countries (which numbered 164 at last count), and members are expected to take their disputes to WTO tribunals for adjudication rather than engage in tit-for-tat trade wars. In addition, the WTO is the guardian of the “most-favored-nation” (MFN) principle, under which member countries pledge to treat each other’s products on a non-discriminatory basis — a valuable bulwark against the formation of hostile trade blocs.

To gain entry to the Geneva-based trade body, China had undergone 15 years of negotiations. US trade officials served as Beijing’s chief interlocutors and tormentors, demanding measures to reform the state-dominated Chinese economy and open the nation’s markets in ways that exceeded the requirements imposed on other nations. For example, China had to promise that it would reduce its tariffs on manufactured goods to an average of about nine percent by 2005 — less than one-third of the comparable figures for Brazil, Argentina, India and Indonesia. Beijing also had to agree that for a number of years, its trading partners could use several unusual mechanisms that could restrict the inflow of Chinese products into their markets. The main reason Chinese officials accepted such severe conditions was that WTO membership conferred enormous potential benefits, in particular protection against the arbitrary imposition of sanctions on Chinese exports. After numerous fits and starts and near-collapses, the talks finally ended with China’s formal admission at a conference of ministers from WTO member countries in November 2001. With the inclusion of China, a nation of 1.25 billion at the time, the “W” in the trade body’s acronym attained validity that it previously lacked.

Transformative results ensued, as thousands of Chinese laws and regulations were changed or scrapped to conform with commitments Beijing had made to join. In response to the much greater openness and predictability of the market, foreign companies’ China-based operations expanded dramatically. The economy, which had already grown robustly during the 1980s and 1990s, lifting hundreds of millions of Chinese out of poverty, surged on an even steeper upward trajectory during the first decade after entry into the WTO, as GDP quadrupled, while exports almost quintupled. Throughout the world, consumers saved tidy sums by buying more made-in-China products, and producers cranked up exports to satisfy booming Chinese demand. Economic liberalization and the adoption of reforms promoting the rule of law afforded hope in the early 2000s that China was on a gradual path toward true free enterprise — if not fully unbridled then at least a form similar to that in, say, South Korea. In a 2002 book that he co-authored, WTO Director-General Supachai Panitchpakdi enthused: “The agreement signals China’s willingness to play by international trade rules and to bring its often opaque and cumbersome government apparatus into harmony with a world order that demands clarity and fairness.”

But such optimism was rooted in a failure to anticipate how China’s economic policies would evolve — and how those policies would flummox trading partners trying to identify rules that Beijing might be accused of violating.

Starting around 2003, and continuing for about a decade thereafter, China kept the exchange rate of its currency pegged at artificially low levels, bestowing significant competitive advantages on Chinese exporters. That exacerbated a phenomenon that has come to be known as the “China shock,” which refers to the decimation of manufacturing companies in a number of American blue-collar communities.

Also in 2003, Beijing established institutions giving it tighter and more efficient control over the management of giant state-owned enterprises (SOEs) and banks, the setting of prices for key commodities and inputs, allocation of subsidies, enforcement of regulations and approval of investments. By the time of the 2010 ship collision, China’s leaders were guiding the country in a new direction, variously dubbed “state capitalism,” “techno-nationalism” and “China Inc.” Although the private sector was vibrant and flourishing — by one estimate, it accounted for roughly two-thirds of China’s GDP — intervention by the government and the Communist Party was becoming far more pervasive than before. Foreign firms that had once been welcomed with open arms were fuming about falling victim to a bewildering array of obstacles and industrial policies aimed at promoting and protecting Chinese competitors favored by the party-state. High on the list of gripes were tactics effectively forcing the handover of proprietary technology, or the purchase of inputs from domestic suppliers, as the price of access to the vast Chinese market. Concerns about these policies greatly intensified after the rise of Xi Jinping as China’s paramount leader in 2012, notably when Beijing launched a plan called “Made in China 2025” aimed at fostering national self-sufficiency in critical sectors such as new-energy vehicles, biomedicine and robotics. In theory, the WTO provides the means to remedy such problems — and in numerous instances, countries have brought complaints against China to the trade body and won; Beijing generally complies by changing its policies in accord with rulings by WTO tribunals. But China’s system has become so opaque and uniquely structured that many of its practices fall beyond the scope of the trade body’s rules and bedrock principles. This challenge is of existential importance to the WTO given the outsize dimensions of China’s market and external trade. (China is the world’s largest exporter, with about 13 percent of the global total in 2017.) The administration of US President Donald Trump is dismissive of the WTO’s efficacy with regard to China — that was one of Washington’s main justifications for starting a trade war against Beijing — and for all the president’s misconceptions about trade, he and his acolytes are by no means alone on this score. Their frustration is shared by trade experts across a broad swath of the political spectrum.

This book chronicles China’s entry into the WTO and the profound changes that this development has engendered — for both good and ill — for China, for its trading partners (in particular, its most important, the United States) and for the trading system writ large. The rise of the Chinese economic juggernaut is traced, as is the deviation in Beijing’s economic modus operandi from the expectations of other WTO member countries. Also recounted are the efforts by non-Chinese officials and political actors, chiefly Americans, to address China’s most problematic policies; in addition, the book examines the parts played by multilateral institutions, specifically the WTO and the International Monetary Fund (IMF). The narrative culminates in the Sino-US trade war and related events of 2018-2019 that have brought the trading system to a breaking point.

The book proceeds along chronological lines with detours to explore major themes, as follows: Chapters 2 and 3 recount China’s long quest to gain the rights and privileges of WTO membership. These chapters make clear that US negotiators, who have been criticized for striking the deal, were anything but lax in demanding concessions. Chapter 4 examines the period immediately after the 2001 inception of China’s membership, when Beijing embraced the required reforms and market opening with apparent sincerity and even excitement. Events covered in this chapter also include the takeoff in Chinese exports and the China shock. Chapter 5 tells the tale of China’s currency practices and provides a detailed account of the futile attempts by the IMF to rectify the alleged “misalignment” of foreign exchange rates.

China’s increasingly statist economic approach under the presidency of Hu Jintao (2002–2012) is the subject of chapter 6, which also explores the sluggishness of the George W. Bush administration’s response and mounting antagonism over Beijing’s industrial policies. Chapter 7 presents a granular look at two WTO cases involving China, to illuminate the issue of whether the trade body is equipped to handle Beijing’s economic practices. That is followed by an account in chapter 8 of Xi’s reign, which started out appearing market-oriented but soon revealed itself to be significantly more interventionist than Hu’s. In chapter 9, one highly touted initiative for countering China’s trade policies — the Trans-Pacific Partnership (TPP) — undergoes critical scrutiny. The tenth chapter appraises the Trump administration’s approach — the slapping of tariffs on $250 billion worth of Chinese imports, to which China responded with retaliatory actions before the two sides agreed to try negotiating a settlement.

The book’s conclusion, also presented in chapter 10, is that the huge challenge posed by China Inc. warrants a much more forceful response than the multilateral trading system has delivered so far — but rather than Trump-style bullying, the right way forward would be to double down on multilateralism. In support of this proposition, chapter 11 presents multilateral strategies that hold substantial promise for ameliorating China-related trade concerns. Because Trump and his team pursued unilateralism instead — bludgeoning countries with tariffs on no real authority but their own say-so — they ignored approaches that could have worked better and they inflicted damage on the WTO that is even more detrimental than the Chinese practices they can reasonably expect to stop. That conclusion will stand regardless of the outcome of the US-China negotiations, which were continuing as this book went to the printer in the spring of 2019.

This series of events is integral to the evolution of global capitalism in the twenty-first century — dispiriting history for those who believe, as I do, in the benefits of both free markets and robust international governance.

China’s admission to the WTO was a capstone of US-led economic globalization, which had been on a roll in the 1990s with the approval of the North American Free Trade Agreement (NAFTA) and the international pact that included the WTO’s creation. Comeuppance came in 2007-2008, when the outbreak of the global financial crisis brought glaring defects in the American model to the fore — and, as we shall see, the crisis also stymied efforts to modify China’s policies. Increasingly confident in the virtues of its own model, Beijing diverged from the economic approach of its trading partners; in so doing, it undermined support for the WTO system abroad. Now the foundations of that system have been fractured by the capricious behavior and contempt for international rules of the current US president.

Further deterioration may well lie in store, in the form of a deepening US-China schism. That word, the title of this book, has one dictionary definition — “discord, disharmony” — that already applies to the world’s two biggest economies, given their disparate economic models, toxic mutual distrust and conflicting interests. Incipient signs of a more full-fledged schism — meaning a major reversal of Sino-American economic integration or even a division of the global economy into separate and exclusive blocs — should be viewed as ominous.

That prospect arose during the trade wars of 2018-2019, amid the dislocation of multinational supply chains and rumblings from Washington about the desirability of a US-China “decoupling.” The specter grew more tangible in mid-May 2019, right at the deadline for finishing touches on this book, when a breakdown in negotiations led Trump to order a sharp increase in the tariffs already levied on $200 billion worth of Chinese imports and the initiation of plans to hit all the other goods shipped from China to the United States. (China vowed to “take necessary countermeasures.”) The most serious potential for schism stems from the battle over next-generation telecommunications, which is fraught with tension over espionage and technological ascendancy. The US government has leveled criminal charges against Huawei, the world’s leading telecom equipment maker, and sought to block Huawei and other Chinese firms from building networks in overseas markets. One all-too-plausible upshot of the strife over Huawei is a sundering of the global market for many high-tech goods and services.

Be not comforted, even if the US-China negotiations of 2019 end with a signing ceremony at which Trump and Xi jointly rescind tariffs and exchange vows of eternal friendship. In early April, Trump predicted a “very monumental” agreement, and a deal similar to the one that was reportedly taking shape then — assuming it is finalized — may alleviate strains. But the toll taken on the trading system has also been monumental, and any pact the two sides reach will fall well short of permanently resolving their differences. China’s political and economic system is not about to change in fundamental ways, nor is the US political establishment about to alter its conclusion that China is America’s most formidable strategic rival. With Cold War-like antagonism and suspicion on the rise, Washington and Beijing are contriving to minimize dependence on each other for key technologies. Schism will remain a clear and present danger, and conflict between China and its trading partners will be ongoing.

A proper grasp of China’s WTO saga is therefore essential to arrive at informed opinions about the nation’s trade regime; sound assessment requires understanding the historical background. Yet false and misleading interpretations of China Inc’s evolution abound. One is that China was granted entry into the WTO on easy terms; here are others — uttered not by tub-thumping protectionists but by respectable commentators:

“China astutely knew what it had to promise to gain access to the WTO club, and it made these promises, but its subsequent actions demonstrate that China had no real intention of keeping them.”

“China is a member of the WTO. It’s supposed to live up to certain requirements, and it lives up to virtually none of them.”

“China is a trade cheat. [Its actions] directly contradict [its] commitments when it joined the World Trade Organization in 2001.”

Such assertions are not only historically inaccurate and unfair to the policymakers involved, they lead to poorly grounded conclusions and policy choices that can be encapsulated in arguments that run roughly as follows: “We’ve been weak against China — all that’s needed is some backbone”; “Let’s give the Chinese a dose of their own medicine — they don’t care about the rules, so we shouldn’t either”; and “Nothing but unilateral action will work.”

It would be Pollyannaish in the extreme, of course, to credit Beijing with honoring the spirit of the WTO’s rules as faithfully as their letter. As later chapters will show, China’s trade mandarins are ingenious at detecting loopholes in WTO texts and exploiting the system’s weaknesses. Even more important is the Chinese system’s singular lack of transparency. Nobody can tell for sure when orders are being surreptitiously given for state-controlled firms and banks to conduct business or negotiations in ways that promote Beijing’s industrial policy goals and unfairly disadvantage foreign competitors, but the evidence that such practices exist is persuasive if not conclusive in every instance. Foreigners often shrink from complaining for fear of retaliation by regulators wielding arbitrary power over corporate fortunes. Randal Phillips, a former Central Intelligence Agency (CIA) official in China who now heads the Asia offices of the Mintz Group, a consultancy for multinational companies, told me, “We’ve had clients who have literally been scared to even approach the US embassy, in case they were seen entering.”

Comprehending these practices, the tale of how they developed and why they’ve proven so intractable is also crucial to the formulation of a sensible approach toward China. Turning a blind eye to their use by the world’s second-largest economy is unthinkable; the schism that separates China’s economic model from that of other nations must be squarely faced. But China’s affront to the WTO’s foundational tenets is not the same as absence of respect for the rules, and that is a distinction with a substantial difference. The distinction is especially important when it comes to deciding whether and how to defend the rules-based system.

The WTO’s value — and limitations — are the subtext of the narrative that unfolds in chapters to come. Even to well-informed laypeople, the trade body is a puzzlement, but there are few better backdrops for demystifying the system than the “enter the dragon” spectacle of the China story.

A few reminders of what the system is not: it is not “free trade,” or “fair trade” or even “reciprocal trade,” as those terms are commonly understood. All WTO members maintain some barriers to other countries’ products, usually to accommodate the demands of narrow interest groups, thereby sustaining political support for the general openness that is necessary for economic dynamism. Unjust as it may seem, some countries are bigger “sinners” than others, by maintaining more and higher tariffs and other obstacles than their trading partners. And barriers lack “reciprocity” in the sense that tariffs are not equalized for like products in all countries. Different nations insist on protecting different producers — in Canada, as the world learned during the acrimonious Group of Seven summit in June 2018, dairy farmers have long been coddled, while in the United States, the most sheltered include sugar growers and pickup truck manufacturers.

But the system is pretty free, pretty fair and pretty reciprocal. In multilateral agreements reached over past decades, countries bargained based on reciprocity of concessions — that is, each would open its markets to the extent that it could extract enough from its trading partners to make a deal attractive. Many of the provisions involved issues other than tariffs, notably the protection of intellectual property; one reason the United States accepted the imposition of higher tariffs on certain items by other WTO countries was that Washington put top priority on securing legal guarantees abroad against copying of high- value products made in Hollywood and Silicon Valley. The resulting system doesn’t end all protectionism or eliminate all egregious conduct, but it does constrain those problems to reasonably acceptable levels.

The rules sometimes tilt too far in favor of corporate interests, reflecting the influence of lobbies, such as the pharmaceutical industry. But the WTO has kept global commerce from operating according to rule-of-the-jungle, might-makes-right principles. To the extent it continues to do so — an increasingly shaky assumption, in view of Trump’s coercive tactics and threats to withdraw — it provides a global public good, from which all nations broadly benefit and no single nation can deliver alone. In the same way that a police force provides the public good of law enforcement at the local level, and a military provides the public good of defense at the national level, the WTO provides the public good of (relatively) open markets at the global level. The resulting stability and predictability of the business environment helps foster economic growth and investment; in the absence of such stability — with trade barriers rising and falling based on the whims of the powerful — corporate executives and entrepreneurs will naturally turn skittish about building or expanding their business operations.

That should be kept in mind while reading in chapter 10 about the actions Trump has taken, and in chapters 5, 6 and 8 about China’s transgressions. The system is obviously well worth preserving; on the other hand, how long can it survive if the rules inadequately address legitimate grievances about the actions of a major player? Also worth bearing in mind is what might be called the great counterfactual — that is, how China would have developed if it had been kept out of the WTO. Counterfactuals are by definition unamenable to proof, but having intensively reviewed China’s development since 2001, I believe it is beyond dispute that WTO membership has made the Chinese economy more open and liberal than it would have been otherwise.

Nor should this book be read without due consideration to the sheer scale of human advancement that China has achieved during its WTO era. No one aware of the wretched conditions in Chinese villages and cities in the late twentieth century can fail to be inspired by the statistics on poverty reduction: in 2002, 409 million Chinese still fell under the international poverty line as defined by the World Bank; a dozen years later, that number had dwindled to 18 million, a mere 1.4 percent of the population. Prosperity has made it possible for the nation to make great strides in cleaning up its air and water and contribute meaningfully to international progress on climate change.

Yet China’s new-found wealth has also begotten many untoward consequences. It has helped legitimize the iron grip of the Communist Party and financed an aggressive military posture in the South and East China Seas. It is also funding the development of databases using facial recognition and other forms of high-tech surveillance to clamp down on dissent and induce Party-approved behavior among the nation’s citizenry, making a mockery of predictions by the likes of President Bill Clinton that WTO membership would enhance prospects for the Chinese people to attain political freedom.

This book makes no pretense to covering problems involving China’s military or diplomatic policies, human rights, espionage or other non-trade issues except insofar as they relate to trade. I am well aware of the viewpoint that China has become a dangerous adversary to the United States and its allies, and I acknowledge that national security must take precedence over commercial interests, so schism is inevitable to some degree — keeping militarily valuable technology from falling into Beijing’s hands being one obvious justification. But the deeper the schism, the greater the economic cost; unlike the circumstances during the Cold War with the Soviet Union, China is extensively intertwined with the global economy. This book’s underlying assumption, therefore, is that to the maximum possible extent, trade with China should be grounded in policies and rules aimed at promoting mutual benefit and enrichment. Determining how best to do that is challenging enough without taking competing objectives into account. Worthy as it undoubtedly is to combat Beijing’s oppression at home and threats to liberal democracy abroad, I leave those subjects to others, who can hopefully devise solutions at costs that liberal democracies are willing to bear.

China never promised to be America’s ally, or anyone else’s ally for that matter. Nor did it promise to become a Western-style democracy — hopes for such a development have proven to be an American conceit. China did give myriad undertakings, however, when it joined the WTO. The full ramifications of that agreement are still unfolding, and now is a particularly opportune time to take stock, in a story that begins in globalization’s halcyon days.

Schism: China, America and the Fracturing of the Global Trading System (Centre for International Governance Innovation), $35.00